UNUNITEDITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
| ☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended AugustMay 31, 20192020
| ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ________to________
Commission file number: 001-36865
Rocky Mountain Chocolate Factory, Inc.
(Exact name of registrant as specified in its charter)
Delaware | 47-1535633 |
(State or other jurisdiction of
| (I.R.S. Employer Identification No.) |
265 Turner Drive, Durango, CO 81303
(Address of principal executive offices, including zip code)
(970) 259-0554
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading symbol | Name of each exchange on which registered |
Common Stock, $0.001 par value per share | RMCF | Nasdaq Global Market |
Preferred Stock Purchase Rights | RMCF | Nasdaq Global Market |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ☐ | Accelerated filer | ☐ |
Non-accelerated filer | ☐ | Smaller reporting company | ☒ |
Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
On October 1, 2019,June 25, 2020, the registrant had outstanding 5,994,9976,065,138 shares of its common stock, $0.001 par value.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
FORM 10-Q
PART I. | FINANCIAL INFORMATION | 3 |
Item 1. | Financial Statements | 3 | |
Item 4. | Controls and Procedures | 25 | |
PART II. | OTHER INFORMATION | ||
Item 1. | Legal Proceedings | 26 | |
Item 1A. | Risk Factors | 26 | |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 27 | |
Item 3. | Defaults Upon Senior Securities | 27 | |
Item 4. | Mine Safety Disclosures | 27 | |
Item 5. | Other Information | 27 | |
Item 6. | Exhibits | 28 | |
29 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOMEOPERATIONS
(unaudited)
Three Months Ended August 31, | Six Months Ended August 31, | Three Months Ended May 31, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | 2020 | 2019 | |||||||||||||||||||
Revenues | ||||||||||||||||||||||||
Sales | $ | 5,384,040 | $ | 5,736,319 | $ | 11,844,651 | $ | 12,318,368 | $ | 2,322,211 | $ | 6,460,611 | ||||||||||||
Franchise and royalty fees | 2,001,230 | 2,063,769 | 3,966,618 | 3,847,805 | 380,226 | 1,965,388 | ||||||||||||||||||
Total Revenue | 7,385,270 | 7,800,088 | 15,811,269 | 16,166,173 | 2,702,437 | 8,425,999 | ||||||||||||||||||
Costs and Expenses | ||||||||||||||||||||||||
Cost of sales | 3,738,435 | 3,883,884 | 8,353,179 | 8,549,126 | 2,883,216 | 4,614,744 | ||||||||||||||||||
Franchise costs | 441,638 | 582,798 | 924,651 | 1,076,048 | 421,245 | 483,013 | ||||||||||||||||||
Sales and marketing | 434,782 | 565,212 | 991,433 | 1,153,462 | 474,090 | 556,651 | ||||||||||||||||||
General and administrative | 830,451 | 813,388 | 1,975,182 | 1,727,835 | 3,179,475 | 1,144,731 | ||||||||||||||||||
Retail operating | 469,304 | 498,856 | 918,206 | 1,061,328 | 319,211 | 448,902 | ||||||||||||||||||
Depreciation and amortization, exclusive of depreciation and amortization expense of $147,415, $138,212, $293,114 and $274,717, respectively, included in cost of sales | 225,417 | 296,737 | 457,372 | 597,737 | ||||||||||||||||||||
Depreciation and amortization, exclusive of depreciation and amortization expense of $157,510, $145,699, respectively, included in cost of sales | 185,605 | 231,955 | ||||||||||||||||||||||
Costs associated with Company-owned store closures | - | 118,793 | - | 176,981 | 68,558 | - | ||||||||||||||||||
Total costs and expenses | 6,140,027 | 6,759,668 | 13,620,023 | 14,342,517 | 7,531,400 | 7,479,996 | ||||||||||||||||||
Income from Operations | 1,245,243 | 1,040,420 | 2,191,246 | 1,823,656 | ||||||||||||||||||||
(Loss) Income from Operations | (4,828,963 | ) | 946,003 | |||||||||||||||||||||
Other Income (Expense) | ||||||||||||||||||||||||
Interest Expense | (3,487 | ) | (19,418 | ) | (15,885 | ) | (42,057 | ) | (23,562 | ) | (12,398 | ) | ||||||||||||
Interest Income | 6,007 | 4,627 | 16,186 | 9,204 | 5,800 | 10,179 | ||||||||||||||||||
Other income (expense), net | 2,520 | (14,791 | ) | 301 | (32,853 | ) | (17,762 | ) | (2,219 | ) | ||||||||||||||
Income Before Income Taxes | 1,247,763 | 1,025,629 | 2,191,547 | 1,790,803 | ||||||||||||||||||||
(Loss) Income Before Income Taxes | (4,846,725 | ) | 943,784 | |||||||||||||||||||||
Income Tax Provision | 329,675 | 274,814 | 561,850 | 463,044 | ||||||||||||||||||||
Income Tax (Benefit) Provision | (1,179,328 | ) | 232,175 | |||||||||||||||||||||
Consolidated Net Income | $ | 918,088 | $ | 750,815 | $ | 1,629,697 | $ | 1,327,759 | ||||||||||||||||
Consolidated Net (Loss) Income | $ | (3,667,397 | ) | $ | 711,609 | |||||||||||||||||||
Basic Earnings per Common Share | $ | 0.15 | $ | 0.13 | $ | 0.27 | $ | 0.22 | ||||||||||||||||
Diluted Earnings per Common Share | $ | 0.15 | $ | 0.13 | $ | 0.26 | $ | 0.22 | ||||||||||||||||
Basic (Loss) Earnings per Common Share | $ | (0.61 | ) | $ | 0.12 | |||||||||||||||||||
Diluted (Loss) Earnings per Common Share | $ | (0.61 | ) | $ | 0.11 | |||||||||||||||||||
Weighted Average Common Shares Outstanding - Basic | 5,977,746 | 5,923,351 | 5,970,012 | 5,914,383 | ||||||||||||||||||||
Dilutive Effect of Employee Stock Awards | 279,584 | 59,479 | 275,935 | 68,536 | ||||||||||||||||||||
Weighted Average Common Shares Outstanding - Diluted | 6,257,330 | 5,982,830 | 6,245,947 | 5,982,919 | ||||||||||||||||||||
Weighted Average Common Shares | ||||||||||||||||||||||||
Outstanding - Basic | 6,058,851 | 5,962,278 | ||||||||||||||||||||||
Dilutive Effect of Employee | ||||||||||||||||||||||||
Stock Awards | - | 272,286 | ||||||||||||||||||||||
Weighted Average Common Shares | ||||||||||||||||||||||||
Outstanding - Diluted | 6,058,851 | 6,234,564 |
The accompanying notes are an integral part of these consolidated financial statements.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
August 31, | February 28, | |||||||||||||||
2019 | 2019 | May 31, | February 29, | |||||||||||||
| (unaudited) | 2020 | 2020 | |||||||||||||
Assets | (unaudited) | |||||||||||||||
Current Assets | ||||||||||||||||
Cash and cash equivalents | $ | 5,753,209 | $ | 5,384,027 | $ | 7,440,923 | $ | 4,822,071 | ||||||||
Accounts receivable, less allowance for doubtful accounts of $585,306 and $489,502, respectively | 4,017,572 | 3,993,262 | ||||||||||||||
Notes receivable, current portion | 134,926 | 110,162 | ||||||||||||||
Accounts receivable, less allowance for doubtful accounts of $1,908,912 and $638,907, respectively | 2,320,580 | 4,049,959 | ||||||||||||||
Notes receivable, current portion, less current portion of the valuation allowance of $50,814 and $0, respectively | 110,624 | 160,700 | ||||||||||||||
Refundable income taxes | 44,726 | 190,201 | 417,979 | 418,319 | ||||||||||||
Inventories, less reserve for slow moving inventory of $178,658 and $371,147, respectively | 4,195,198 | 4,270,357 | ||||||||||||||
Inventories | 4,140,827 | 3,750,978 | ||||||||||||||
Other | 465,876 | 318,126 | 397,311 | 409,703 | ||||||||||||
Total current assets | 14,611,507 | 14,266,135 | 14,828,244 | 13,611,730 | ||||||||||||
Property and Equipment, Net | 5,857,664 | 5,786,139 | 5,703,584 | 5,938,013 | ||||||||||||
Other Assets | ||||||||||||||||
Notes receivable, less current portion | 317,507 | 281,669 | ||||||||||||||
Notes receivable, less current portion and valuation allowance of $149,186 and $0, respectively | 124,912 | 289,515 | ||||||||||||||
Goodwill, net | 1,046,944 | 1,046,944 | 729,701 | 1,046,944 | ||||||||||||
Franchise rights, net | 3,363,304 | 3,678,920 | 2,915,707 | 3,047,688 | ||||||||||||
Intangible assets, net | 460,865 | 498,337 | 421,864 | 498,393 | ||||||||||||
Deferred income taxes | 505,462 | 607,421 | 1,809,407 | 630,078 | ||||||||||||
Lease right of use asset | 3,066,826 | - | 2,518,444 | 2,698,765 | ||||||||||||
Other | 56,264 | 56,576 | 56,263 | 56,262 | ||||||||||||
Total other assets | 8,817,172 | 6,169,867 | 8,576,298 | 8,267,645 | ||||||||||||
Total Assets | $ | 29,286,343 | $ | 26,222,141 | $ | 29,108,126 | $ | 27,817,388 | ||||||||
Liabilities and Stockholders' Equity | ||||||||||||||||
Current Liabilities | ||||||||||||||||
Current maturities of long term debt | $ | 480,445 | $ | 1,176,488 | $ | 590,377 | $ | - | ||||||||
Line of credit | 3,448,165 | - | ||||||||||||||
Accounts payable | 1,295,732 | 897,074 | 2,965,103 | 2,241,506 | ||||||||||||
Accrued salaries and wages | 597,856 | 655,853 | 779,037 | 716,860 | ||||||||||||
Gift card liabilities | 648,142 | 742,289 | 605,437 | 609,842 | ||||||||||||
Other accrued expenses | 291,353 | 293,094 | 294,434 | 316,751 | ||||||||||||
Dividend payable | 719,359 | 714,939 | - | 722,344 | ||||||||||||
Contract liabilities | 239,278 | 256,094 | 193,492 | 195,658 | ||||||||||||
Lease liability | 808,989 | - | 803,106 | 803,861 | ||||||||||||
Total current liabilities | 5,081,154 | 4,735,831 | 9,679,151 | 5,606,822 | ||||||||||||
Lease Liability, Less Current Portion | 2,257,837 | - | 1,715,338 | 1,894,904 | ||||||||||||
Long-Term Debt, Less Current Portion | 948,047 | - | ||||||||||||||
Contract Liabilities, Less Current Portion | 976,651 | 1,096,478 | 933,758 | 960,151 | ||||||||||||
Commitments and Contingencies | ||||||||||||||||
Stockholders' Equity | ||||||||||||||||
Preferred stock, $.001 par value per share; 250,000 authorized; -0- shares issued and outstanding | - | - | - | - | ||||||||||||
Series A Junior Participating Preferred Stock, authorized 50,000 shares | - | - | ||||||||||||||
Undesignated series, authorized 200,000 shares | - | - | ||||||||||||||
Common stock, $.001 par value, 46,000,000 shares authorized, 5,991,162 shares and 5,957,827 shares issued and outstanding, respectively | 5,991 | 5,958 | ||||||||||||||
Series A Junior Participating Preferred Stock, 50,000 authorized; -0- shares issued and outstanding | - | - | ||||||||||||||
Undesignated series, 200,000 shares authorized; -0- shares issued and outstanding | - | - | ||||||||||||||
Common stock, $.001 par value, 46,000,000 shares authorized, 6,060,663 shares and 6,019,532 shares issued and outstanding, respectively | 6,061 | 6,020 | ||||||||||||||
Additional paid-in capital | 7,037,501 | 6,650,864 | 7,603,608 | 7,459,931 | ||||||||||||
Retained earnings | 13,927,209 | 13,733,010 | 8,222,163 | 11,889,560 | ||||||||||||
Total stockholders' equity | 20,970,701 | 20,389,832 | 15,831,832 | 19,355,511 | ||||||||||||
Total Liabilities and Stockholders' Equity | $ | 29,286,343 | $ | 26,222,141 | $ | 29,108,126 | $ | 27,817,388 |
The accompanying notes are an integral part of these consolidated financial statements.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended | Three Months Ended | |||||||||||||||
August 31, | May 31, | |||||||||||||||
2019 | 2018 | 2020 | 2019 | |||||||||||||
Cash Flows From Operating Activities | ||||||||||||||||
Net Income | $ | 1,629,697 | $ | 1,327,759 | ||||||||||||
Net (loss) income | $ | (3,667,397 | ) | $ | 711,609 | |||||||||||
Adjustments to reconcile net income to net cash provided by operating activities: | Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||||||
Depreciation and amortization | 750,486 | 872,454 | 343,115 | 377,654 | ||||||||||||
Provision for obsolete inventory | 47,945 | 57,614 | ||||||||||||||
Provision for loss on accounts and notes receivable | 108,283 | 40,800 | 1,468,815 | 81,283 | ||||||||||||
Asset impairment and store closure losses | - | 67,822 | 544,060 | - | ||||||||||||
Loss on sale or disposal of property and equipment | 5,796 | 26,020 | 4,956 | 2,867 | ||||||||||||
Expense recorded for stock compensation | 386,670 | 280,728 | 143,718 | 231,254 | ||||||||||||
Deferred income taxes | 101,959 | 38,814 | (1,179,329 | ) | 38,028 | |||||||||||
Changes in operating assets and liabilities: | ||||||||||||||||
Accounts receivable | (267,491 | ) | 421,162 | 476,533 | (100,089 | ) | ||||||||||
Refundable income taxes | 145,475 | 257,685 | 340 | 185,667 | ||||||||||||
Inventories | 212,138 | (1,579,686 | ) | (433,932 | ) | 367,824 | ||||||||||
Contract Liabilities | (27,515 | ) | (90,248 | ) | ||||||||||||
Other current assets | (147,750 | ) | (154,537 | ) | 12,393 | (122,047 | ) | |||||||||
Accounts payable | 213,734 | 58,005 | 680,748 | 115,667 | ||||||||||||
Accrued liabilities | (153,885 | ) | (254,540 | ) | 35,453 | 28,640 | ||||||||||
Contract liabilities | (130,378 | ) | (71,671 | ) | ||||||||||||
Net cash provided by operating activities | 2,902,679 | 1,388,429 | ||||||||||||||
Net cash (used in) provided by operating activities | (1,598,042 | ) | 1,828,109 | |||||||||||||
Cash Flows from Investing Activities | ||||||||||||||||
Proceeds received on notes receivable | 74,296 | 55,612 | 17,825 | 28,400 | ||||||||||||
Purchase of intangible assets | (41,464 | ) | - | |||||||||||||
Purchases of property and equipment | (480,984 | ) | (242,432 | ) | (22,488 | ) | (283,548 | ) | ||||||||
(Increase) decrease in other assets | 312 | (13,717 | ) | |||||||||||||
Decrease in other assets | - | 312 | ||||||||||||||
Net cash used in investing activities | (406,376 | ) | (200,537 | ) | (46,127 | ) | (254,836 | ) | ||||||||
Cash Flows from Financing Activities | ||||||||||||||||
Payments on long-term debt | (696,043 | ) | (670,336 | ) | - | (346,547 | ) | |||||||||
Proceeds from long-term debt | 1,537,200 | - | ||||||||||||||
Proceeds from the line of credit | 3,448,165 | - | ||||||||||||||
Dividends paid | (1,431,078 | ) | (1,417,305 | ) | (722,344 | ) | (715,179 | ) | ||||||||
Net cash used in financing activities | (2,127,121 | ) | (2,087,641 | ) | ||||||||||||
Net cash provided by (used in) financing activities | 4,263,021 | (1,061,726 | ) | |||||||||||||
Net Increase (Decrease) in Cash and Cash Equivalents | 369,182 | (899,749 | ) | |||||||||||||
Net Increase in Cash and Cash Equivalents | 2,618,852 | 511,547 | ||||||||||||||
Cash and Cash Equivalents, Beginning of Period | 5,384,027 | 6,072,984 | 4,822,071 | 5,384,027 | ||||||||||||
Cash and Cash Equivalents, End of Period | $ | 5,753,209 | $ | 5,173,235 | $ | 7,440,923 | $ | 5,895,574 |
The accompanying notes are an integral part of these consolidated financial statements.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(unaudited)
Additional | ||||||||||||||||||||
Common Stock | Paid-in | Retained | ||||||||||||||||||
Shares | Amount | Capital | Earnings | Total | ||||||||||||||||
Balance as of May 31, 2018 | 5,905,436 | $ | 5,905 | $ | 6,286,952 | $ | 14,213,773 | $ | 20,506,630 | |||||||||||
Net income | 750,815 | 750,815 | ||||||||||||||||||
Issuance of common stock, vesting of restricted stock units and other | 43,224 | 43 | (43 | ) | - | |||||||||||||||
Share-based compensation | 124,921 | 124,921 | ||||||||||||||||||
Common stock dividends | (713,839 | ) | (713,839 | ) | ||||||||||||||||
Balance as of August 31, 2018 | 5,948,660 | $ | 5,948 | $ | 6,411,830 | $ | 14,250,749 | $ | 20,668,527 | |||||||||||
Balance as of February 28, 2018 | 5,903,436 | $ | 5,903 | $ | 6,131,147 | $ | 13,419,553 | $ | 19,556,603 | |||||||||||
Net income | 1,327,759 | 1,327,759 | ||||||||||||||||||
Issuance of common stock, vesting of restricted stock units and other | 45,224 | 45 | (45 | ) | - | |||||||||||||||
Share-based compensation | 280,728 | 280,728 | ||||||||||||||||||
Common stock dividends | (1,422,492 | ) | (1,422,492 | ) | ||||||||||||||||
Adoption of ASC 606 | 925,929 | 925,929 | ||||||||||||||||||
Balance as of August 31, 2018 | 5,948,660 | $ | 5,948 | $ | 6,411,830 | $ | 14,250,749 | $ | 20,668,527 | |||||||||||
Balance as of May 31, 2019 | 5,962,327 | $ | 5,962 | $ | 6,882,114 | $ | 13,728,480 | $ | 20,616,556 | |||||||||||
Net income | 918,088 | 918,088 | ||||||||||||||||||
Issuance of common stock, vesting of restricted stock units and other | 28,835 | 29 | (29 | ) | - | |||||||||||||||
Share-based compensation | 155,416 | 155,416 | ||||||||||||||||||
Common stock dividends | (719,359 | ) | (719,359 | ) | ||||||||||||||||
Balance as of August 31, 2019 | 5,991,162 | $ | 5,991 | $ | 7,037,501 | $ | 13,927,209 | $ | 20,970,701 | |||||||||||
Balance as of February 28, 2019 | 5,957,827 | 5,958 | $ | 6,650,864 | $ | 13,733,010 | $ | 20,389,832 | ||||||||||||
Net income | 1,629,697 | 1,629,697 | ||||||||||||||||||
Issuance of common stock, vesting of restricted stock units and other | 33,335 | 33 | (33 | ) | - | |||||||||||||||
Share-based compensation | 386,670 | 386,670 | ||||||||||||||||||
Common stock dividends | (1,435,498 | ) | (1,435,498 | ) | ||||||||||||||||
Balance as of August 31, 2019 | 5,991,162 | $ | 5,991 | $ | 7,037,501 | $ | 13,927,209 | $ | 20,970,701 |
Three Months Ended | ||||||||
May 31, | ||||||||
2020 | 2019 | |||||||
Common Stock | ||||||||
Balance at February 28 or 29: | $ | 6,020 | $ | 5,958 | ||||
Issuance of common stock | - | - | ||||||
Equity compensation, restricted stock units | 41 | 4 | ||||||
Balance at May 31: | 6,061 | 5,962 | ||||||
Additional Paid-in Capital | ||||||||
Balance at February 28 or 29: | 7,459,931 | 6,650,864 | ||||||
Issuance of common stock | - | - | ||||||
Equity compensation, restricted stock units | 143,677 | 231,250 | ||||||
Balance at May 31: | 7,603,608 | 6,882,114 | ||||||
Retained Earnings | ||||||||
Balance at February 28 or 29: | 11,889,560 | 13,733,010 | ||||||
Consolidated net (loss) income | (3,667,397 | ) | 711,609 | |||||
Cash dividends declared | - | (716,139 | ) | |||||
Balance at May 31: | 8,222,163 | 13,728,480 | ||||||
Total Stockholders' Equity | $ | 15,831,832 | $ | 20,616,556 | ||||
Common Shares | ||||||||
Balance at February 28 or 29: | 6,019,532 | 5,957,827 | ||||||
Equity compensation, restricted stock units | 41,131 | 4,500 | ||||||
Balance at May 31: | 6,060,663 | 5,962,327 |
The accompanying notes are an integral part of these consolidated financial statements.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of Operations
The accompanying consolidated financial statements include the accounts of Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, its wholly-owned subsidiaries, Rocky Mountain Chocolate Factory, Inc., a (a Colorado corporation (“RMCF”)corporation), Aspen Leaf Yogurt, LLC a Colorado limited liability company (“ALY”), and U-Swirl International, Inc., a Nevada corporation (“U-Swirl”), and its 46%-owned subsidiary, U-Swirl, Inc., a Nevada corporation (“SWRL”) of which, RMCF had financial control until February 29, 2016 (collectively, the “Company”). All intercompany balances and transactions have been eliminated in consolidation.
The Company is an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, the Company is headquartered in Durango, Colorado and manufactures an extensive line of premium chocolate candies and other confectionery products. U-Swirl franchises and operates soft-serveself-serve frozen yogurt cafés. The Company also sells its candy in selected locations outside of its system of retail stores and licenses the use of its brand with certain consumer products.
U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt.”
The Company’s revenues are currently derived from three principal sources, which are similar for its wholly owned subsidiaries RMCF and U-Swirl: (i)sources: sales to franchisees and others of chocolates and other confectionery products manufactured by the Company; (ii)the collection of initial franchise fees and royalties from franchisees’ sales; and sales at Company-owned stores of chocolates, frozen yogurt, and other confectionery products.
In FY 2020, we entered into a long-term strategic alliance with Edible Arrangements®, LLC and its affiliates (“Edible”) whereby we became the exclusive provider of certain branded chocolate products (includingto Edible, its affiliates and its franchisees. In connection with the Strategic Alliance, the Company entered into a strategic alliance agreement, an exclusive supplier operating agreement and a warrant agreement with EA and Farids. Rocky Mountain Chocolate Factory branded products manufacturedare available for purchase both on Edible’s website as well as through over 1,000 franchised Edible Arrangement locations nationwide. In addition, due to Edible’s significant e-commerce expertise and scale, we have also executed an ecommerce licensing agreement with Edible, whereby Edible sells a wide variety of chocolates, candies and other confectionery products produced by the Company); (iii)Company or its franchisees through Edible’s websites. Edible is also responsible for all ecommerce marketing and sales for the collectionbroader Rocky Mountain ecommerce ecosystem. In January 2020 the founder of initial franchise fees and royalties from franchisees’ salesEdible was elected to the Company’s Board of both confectionary products and frozen yogurt.Directors pursuant to a vote by stockholders held at the Company’s Annual Meeting of Stockholders.
The following table summarizes the number of stores operating1 under the Rocky Mountain Chocolate Factory brand and frozen yogurt cafés as of Augustat May 31, 2019:2020:
Sold, Not Yet Open | Open | Total | Sold, Not Yet Open | Open1 | Total | |||||||||||||||||||
Rocky Mountain Chocolate Factory | ||||||||||||||||||||||||
Company-owned stores | - | 2 | 2 | - | 2 | 2 | ||||||||||||||||||
Franchise stores - Domestic stores and kiosks | 1 | 179 | 180 | 3 | 171 | 174 | ||||||||||||||||||
International license stores | 1 | 63 | 64 | 1 | 61 | 62 | ||||||||||||||||||
Cold Stone Creamery - co-branded | 7 | 95 | 102 | 5 | 98 | 103 | ||||||||||||||||||
U-Swirl (Including all associated brands) | - | |||||||||||||||||||||||
Company-owned stores | - | 1 | 1 | |||||||||||||||||||||
Company-owned stores - co-branded | - | 3 | 3 | - | 3 | 3 | ||||||||||||||||||
Franchise stores - Domestic stores | - | 82 | 82 | - | 74 | 74 | ||||||||||||||||||
Franchise stores - Domestic - co-branded | 1 | 8 | 9 | 1 | 7 | 8 | ||||||||||||||||||
International license stores | - | 2 | 2 | - | 2 | 2 | ||||||||||||||||||
Total | 10 | 435 | 445 | 10 | 418 | 428 |
1 Stores open and operating includes stores that have closed temporarily, the result of COVID-19.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
Basis of Presentation
The accompanying consolidated financial statements have been prepared by the Company, without audit, and reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting and Securities and Exchange Commission (the “SEC”) regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Certain amounts previously presented for prior periods have been reclassified to conform to the current presentation. In the opinion of management, the consolidated financial statements reflect all adjustments (of a normal and recurring nature) which are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations for the three and six months ended AugustMay 31, 20192020 are not necessarily indicative of the results to be expected for the entire fiscal year, or any other future period.year.
These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended February 28, 2019.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS29, 2020.
Subsequent Events
On September 30, 2019Management evaluated all activity of the Company executed a Revolving Linethrough the issue date of Credit Note with Wells Fargo Bank. This document was executed to renew the existing $5 million line of creditfinancial statements and extendconcluded that no subsequent events have occurred that would require recognition or disclosure in the maturity date from September 30, 2019 to September 30, 2021.financial statements.
Recent Accounting PronouncementsCOVID-19 Update
In August 2018, the SEC adopted amendments to certain disclosure requirementsAs discussed in Securities Act Release No. 33-10532, Disclosure Update and Simplification. These amendments eliminate, modify, or integrate into other SEC requirements certain disclosure rules. Among the amendments is the requirement to present an analysis of changes in stockholders’ equity in the interim financial statements included in Quarterly Reports on Form 10-Q. The analysis, which can be presented as a footnote or separate statement, is required for the current and comparative quarter and year-to-date interim periods. The amendments are effective for all filings made on or after November 5, 2018. The Company adopted these amendments in itsmore detail throughout this Quarterly Report on Form 10-Q for the quarter ended May 31, 2019.2020 (this “Quarterly Report”), we have experienced significant business disruptions resulting from efforts to contain the rapid spread of the novel coronavirus (COVID-19), including the vast mandated self-quarantines and closures of non-essential business throughout the United States and internationally. Nearly all of the Company-owned and franchise stores have been directly and negatively impacted by public health measures taken in response to COVID-19, with nearly all locations experiencing reduced operations as a result of, among other things, modified business hours and store and mall closures. As a result, franchisees and licensees are not ordering products for their stores in line with historical amounts. This trend has negatively impacted, and is expected to continue to negatively impact, among other things, factory sales, retail sales and royalty and marketing fees. Beginning in May 2020 most stores previously closed for much of March 2020 and April 2020, in response to COVID-19, began to re-open. Most stores re-opened subject to various local health restrictions and reduced operations. It is unclear when or if store operations will return to pre COVID-19 levels.
In addition, as previously announced on May 11, 2020, the Board of Directors decided to suspend the Company’s first quarter cash dividend payment to preserve cash and provide additional flexibility in the current environment impacted by the COVID-19 pandemic. Furthermore, the Board of Directors has suspended future quarterly dividends until the significant uncertainty of the current public health crisis and economic climate has passed, and the Board of Directors determines that resumption of dividend payments is in the best interest of us and our stockholders.
During this challenging time, the Company’s foremost priority is the safety and well-being of our employees, customers, franchisees and communities. In addition to the already stringent practices for the quality and safety of the Company’s confections, the Company is diligently following health and safety guidance issued by the World Health Organization, the Centers for Disease Control and state and local governmental agencies. COVID-19 has had an unprecedented impact on the retail industry as containment measures continue to impact the Company’s operations and the retail industry. Numerous countries, states and local governments have effected ordinances to protect the public through social distancing, which has caused, and we expect will continue to cause, a significant decrease in, among other things, retail traffic and as a result, factory sales, retail sales and royalty and marketing fees. With that said, Rocky Mountain Chocolate Factory products remain available for sale online. The Company’s current focus is on supporting its franchisees and licensees during this challenging time and driving growth in online sales, especially in light of the ecommerce licensing agreement with Edible, as discussed below, while also sensibly managing costs. The number of Company-owned and franchise stores remaining open may change frequently and significantly due to the ever-changing nature of the COVID-19 outbreak.
In these challenging and unprecedented times, management is taking all necessary and appropriate action to maximize liquidity as the Company navigates the current landscape. These actions include significantly reducing operating expenses and production volume to reflect reduced sales volumes as well as the elimination of all non-essential spending and capital expenditures. Further, in an abundance of caution and to maintain ample financial flexibility, the Company drew down the full amount under our line of credit and the Company received loans under the Paycheck Protection Program (the “PPP”). At May 31, 2020 PPP loans totaled $1.54 million and are presented on the balance sheet as current maturities of long-term debt, and long-term debt based upon the schedule of repayments and excluding any possible foregiveness of the loans. The receipt of funds under the PPP has allowed the Company to temporarily avoid workforce reduction measures amidst a steep decline in revenue and production volume. While the Company believes it has sufficient liquidity with its current cash position, the Company will continue to monitor and evaluate all financing alternatives as necessary as these unprecedented events evolve. For more information, please see Item 1A “Risk Factors—The Novel Coronavirus (COVID-19) Pandemic Has, and May Continue to, Materially and Adversely Affect our Sales, Earnings, Financial Condition and Liquidity” in our Annual Report on Form 10-K as filed on May 29, 2020 with the United States Securities and Exchange Commission.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
Recent Accounting Pronouncements
Except for the recent accounting pronouncements described below, other recent accounting pronouncements are not expected to have a material impact on our condensed consolidated financial statements.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 significantly changes the impairment model for most financial assets and certain other instruments. ASU 2016-13 will require immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets, which will generally result in earlier recognition of allowances for credit losses on loans and other financial instruments. ASU 2016-13 is effective for the Company's fiscal year beginning March 1, 20202023 and subsequent interim periods. The Company is currently evaluating the impact the adoption of ASU 2016-13 will have on the Company's consolidated financial statements.
In February 2016,January 2017, the FASB issued ASU 2016-02, Leases2017-04, Intangibles—Goodwill and Other (Topic 842),350): Simplifying the Test for Goodwill Impairment. This ASU simplifies the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Under the amendments in this ASU, an entity should (1) perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and (2) recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with theunderstanding that the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, ASU 2017-04 requires any reporting unit with a zero or negative carrying amount to perform Step 2 of the recognition of lease assets and lease liabilities on the balance sheet by lesseesgoodwill impairment test. The amendments in this ASU are effective for those leases currently classified as operating leases under ASC 840 “Leases.” These amendments also require qualitative disclosures along with specific quantitative disclosures. The Companyannual periods beginning after December 15, 2019. We adopted this ASU 2016-02 as ofeffective March 1, 2020 (the first quarter of our 2021 fiscal year). The adoption of the ASU did not have a material impact on our consolidated financial statements.
In December 2019, using the modified retrospective method.FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which simplifies the accounting for income taxes. This method allowsguidance will be effective for entities for the fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020 on a prospective basis, with early adoption permitted. We will adopt the new standard effective March 1, 2021 and do not expect the adoption of this guidance to be applied retrospectively throughhave a cumulative catch-up adjustment recognized upon adoption. As a result, comparative information in the Company’smaterial impact on our consolidated financial statements has not been restated and continues to be reported under the accounting standards in effect for those periods. The Company recorded a Right of Use Asset and Lease Liability on the Consolidated Balance Sheet of $3.3 million upon adoption. The impact of the new standard did not affect the Company’s cash flows or results of operations. The lease liability reflects the present value of the Company’s estimated future minimum lease payments over the lease term, which includes options that are likely to be exercised, discounted using an incremental borrowing rate or implicit rate. See Note 11 - Leasing Arrangements for additional information.statements.
NOTE 2 – EARNINGS PER SHARE
Basic earnings per share is calculated using the weighted-average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through the settlement of restricted stock units. Restricted stock units become dilutive within the period granted and remain dilutive until the units vest and are issued as common stock.
NOTE 3 – INVENTORIES
Inventories consist of the following:SUPPLEMENTAL CASH FLOW INFORMATION
August 31, 2019 | February 28, 2019 | |||||||
Ingredients and supplies | $ | 2,347,557 | $ | 2,612,954 | ||||
Finished candy | 1,971,270 | 1,983,854 | ||||||
U-Swirl food and packaging | 55,029 | 44,696 | ||||||
Reserve for slow moving inventory | (178,658 | ) | (371,147 | ) | ||||
Total inventories | $ | 4,195,198 | $ | 4,270,357 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 – PROPERTY AND EQUIPMENT, NET
Property and equipment consists of the following:
August 31, 2019 | February 28, 2019 | |||||||
Land | $ | 513,618 | $ | 513,618 | ||||
Building | 5,031,395 | 5,031,395 | ||||||
Machinery and equipment | 10,205,508 | 10,233,119 | ||||||
Furniture and fixtures | 850,934 | 864,944 | ||||||
Leasehold improvements | 1,151,346 | 1,131,659 | ||||||
Transportation equipment | 435,306 | 422,458 | ||||||
18,188,107 | 18,197,193 | |||||||
Less accumulated depreciation | (12,330,443 | ) | (12,411,054 | ) | ||||
Property and equipment, net | $ | 5,857,664 | $ | 5,786,139 |
Three Months Ended | ||||||||
May 31, | ||||||||
2020 | 2019 | |||||||
Cash paid (received) for: | ||||||||
Interest | $ | 13,362 | $ | 9,814 | ||||
Income taxes | (340 | ) | 8,481 | |||||
Non-cash Operating Activities | ||||||||
Accrued Inventory | 158,834 | 166,649 | ||||||
Non-cash Financing Activities | ||||||||
Dividend payable | $ | - | $ | 715,899 |
NOTE 5 – STOCKHOLDERS’ EQUITY
Cash Dividend
The Company paid a quarterly cash dividend of $0.12 per common share on March 15, 2019 to stockholders of record on March 5, 2019. The Company paid a quarterly cash dividend of $0.12 per share of common stock on June 14, 2019 to stockholders of record on June 4, 2019. The Company declared a quarterly cash dividend of $0.12 per share of common stock on August 16, 2019, which was paid on September 13, 2019 to stockholders of record on September 4, 2019.
Future declaration of dividends will depend on, among other things, the Company's results of operations, capital requirements, financial condition and on such other factors as the Board of Directors may in its discretion consider relevant and in the best long-term interest of the Company’s stockholders.
Stock Repurchases
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2019. As of August 31, 2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
Stock-Based Compensation
The Company’s 2007 Equity Incentive Plan (as amended and restated on August 8, 2013) authorizes the granting of stock awards to employees, non-employee directors, consultants and other participants, including stock options, restricted stock and restricted stock units.
The Company recognized $155,416 and $386,670 of stock-based compensation expense during the three- and six-month periods ended August 31, 2019, respectively, compared to $124,921 and $280,728 during the three- and six-month periods ended August 31, 2018, respectively. Compensation costs related to stock-based compensation are generally amortized over the vesting period of the stock awards.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes restricted stock unit activity during the six months ended August 31, 2019 and 2018:
Six Months Ended | ||||||||
August 31, | ||||||||
2019 | 2018 | |||||||
Outstanding non-vested restricted stock units as of February 28: | 25,002 | 77,594 | ||||||
Granted | 270,000 | - | ||||||
Vested | (28,502 | ) | (43,224 | ) | ||||
Cancelled/forfeited | - | (200 | ) | |||||
Outstanding non-vested restricted stock units as of August 31: | 266,500 | 34,170 | ||||||
Weighted average grant date fair value | $ | 9.40 | $ | 12.05 | ||||
Weighted average remaining vesting period (in years) | 5.14 | 0.88 |
The Company issued an aggregate of 4,833 fully vested, unrestricted shares of common stock to non-employee directors during the six months ended August 31, 2019 compared to an aggregate of 2,000 shares issued during the six months ended August 31, 2018. In connection with these non-employee director stock issuances, the Company recognized $45,652 and $24,480 of stock-based compensation expense during the six months ended August 31, 2019 and 2018, respectively.
During the three- and six-month periods ended August 31, 2019, the Company recognized $152,289 and $341,018, respectively, of stock-based compensation expense related to restricted stock unit grants. The restricted stock unit grants generally vest in equal annual or quarterly installments over a period of five to six years. During the six-month periods ended August 31, 2019 and 2018, 28,502 and 43,224 restricted stock units vested and were issued as common stock, respectively. Total unrecognized compensation expense of non-vested, non-forfeited restricted stock units granted as of August 31, 2019 was $2,309,265, which is expected to be recognized over the weighted-average period of 5.14 years.
The Company has no outstanding stock options as of August 31, 2019.
NOTE 63 – SUPPLEMENTAL CASH FLOW INFORMATIONREVENUE FROM CONTRACTS WITH CUSTOMERS
Effective March 1, 2018, the Company adopted ASC 606, whichprovides that revenues are to be recognized when control of promised goods or services is transferred to a customer in an amount that reflects the consideration expected to be received for those goods or services. This new standard does not impact the Company's recognition of revenue from sales of confectionary items to the Company’s franchisees and others, or in its Company-owned stores as those sales are recognized at the time of the underlying sale and are presented net of sales taxes and discounts. The standard also does not change the recognition of royalties and marketing fees from franchised or licensed locations, which are based on a percent of sales and recognized at the time the sales occur. The standard does change the timing in which the Company recognizes initial fees from franchisees and licensees for new franchise locations and renewals that affect the term of the franchise agreement. The Company generally receives a fee associated with the Franchise Agreement or License Agreement (collectively “Customer Contracts”) at the time that the Customer Contract is entered. These Customer Contracts have a term of up to 20 years, however the majority of Customer Contracts have a term of 10 years. During the term of the Customer Contract the Company is obligated to many performance obligations that the Company has not determined are distinct. The resulting treatment of revenue from Customer Contracts is that the revenue is recognized proportionately over the life of the Customer Contract.
Six Months Ended | ||||||||
August 31, | ||||||||
| 2019 | 2018 | ||||||
Cash paid for: | ||||||||
Interest, net | $ | 808 | $ | 33,006 | ||||
Income taxes | 314,417 | 166,545 | ||||||
Non-cash Operating Activities | ||||||||
Accrued Inventory | 237,842 | 96,454 | ||||||
Non-cash Financing Activities | ||||||||
Dividend payable | $ | 719,359 | $ | 713,839 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
Initial Franchise Fees, License Fees, Transfer Fees and Renewal Fees
The Company's policy for recognizing initial franchise and renewal fees through February 28, 2018 was to recognize initial franchise fees upon new store openings and renewals.In accordance with the new guidance, the initial franchise services are not distinct from the continuing rights or services offered during the term of the franchise agreement, and will be treated as a single performance obligation. Beginning March 1, 2018, initial franchise fees are being recognized as the Company satisfies the performance obligation over the term of the franchise agreement, which is generally 10-15 years.
The following table summarizes contract liabilities as of May 31, 2020 and May 31, 2019:
Three Months Ended | ||||||||
May 31: | ||||||||
2020 | 2019 | |||||||
Contract liabilities at the beginning of the year: | $ | 1,155,809 | $ | 1,352,572 | ||||
Revenue recognized | (55,016 | ) | (106,280 | ) | ||||
Contract fees received | 27,500 | 16,032 | ||||||
Amortized gain on the financed sale of equipment | (1,043 | ) | (3,133 | ) | ||||
Contract liabilities at the end of the period: | $ | 1,127,250 | $ | 1,259,191 |
On May 31, 2020, annual revenue expected to be recognized in the future, related to performance obligations that are not yet fully satisfied, are estimated to be the following:
FYE 21 | $ | 146,360 | ||
FYE 22 | 183,708 | |||
FYE 23 | 171,978 | |||
FYE 24 | 139,353 | |||
FYE 25 | 126,070 | |||
Thereafter | 359,781 | |||
Total | $ | 1,127,250 |
Gift Cards
The Company’s franchisees sell gift cards which do not have either expiration dates, or non-usage fees. The proceeds from the sale of gift cards by the franchisees are accumulated by the Company and paid out to the franchisees upon customer redemption. The Company has historically accumulated gift card liabilities and has not recognized breakage associated with the gift card liability. The adoption of ASC 606 requires the use of the “proportionate” method for recognizing breakage, which the Company has not historically utilized. Upon adoption of ASC 606 the Company began recognizing breakage from gift cards when the gift card is redeemed by the customer or the Company determines the likelihood of the gift card being redeemed by the customer is remote (“gift card breakage”). The determination of the gift card breakage rate is based upon Company-specific historical redemption patterns.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 74 – OPERATING SEGMENTSDISAGGREGATION OF REVENUE
The Company classifies its business interests into five reportable segments: Franchising, Manufacturing, Retail Stores, U-Swirl operationsfollowing table presents disaggregated revenue by method of recognition and Other. The accounting policiessegment:
Three Months Ended May 31, 2020
Revenues recognized over time under ASC 606:
| Franchising |
| Manufacturing |
| Retail |
| U-Swirl |
| Total | |||||||||||
Franchise fees | $ | 41,702 | $ | - | $ | - | $ | 13,314 | $ | 55,016 |
Revenues recognized at a point in time:
| Franchising |
| Manufacturing |
| Retail |
| U-Swirl |
| Total | |||||||||||
Factory sales | - | 2,134,615 | - | - | 2,134,615 | |||||||||||||||
Retail sales | - | - | 59,981 | 127,615 | 187,596 | |||||||||||||||
Royalty and marketing fees | 212,092 | - | - | 113,118 | 325,210 | |||||||||||||||
Total | $ | 253,794 | $ | 2,134,615 | $ | 59,981 | $ | 254,047 | $ | 2,702,437 |
Three Months Ended May 31, 2019
Revenues recognized over time under ASC 606:
| Franchising |
| Manufacturing |
| Retail |
| U-Swirl |
| Total | |||||||||||
Franchise fees | $ | 80,019 | $ | - | $ | - | $ | 26,261 | $ | 106,280 |
Revenues recognized at a point in time:
| Franchising |
| Manufacturing |
| Retail |
| U-Swirl |
| Total | |||||||||||
Factory sales | - | 5,606,020 | - | - | 5,606,020 | |||||||||||||||
Retail sales | - | - | 232,419 | 622,172 | 854,591 | |||||||||||||||
Royalty and marketing fees | 1,347,736 | - | - | 511,372 | 1,859,108 | |||||||||||||||
Total | $ | 1,427,755 | $ | 5,606,020 | $ | 232,419 | $ | 1,159,805 | $ | 8,425,999 |
NOTE 5 – INVENTORIES
Inventories consist of the segments are the same as those described in the summary of significant accounting policies in Note 1 to these consolidated financial statementsfollowing inventory at May 31, 2019 and Note 1 to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2019. The Company evaluates performance and allocates resources based on operating contribution, which excludes unallocatedcorporate general and administrative costs and income tax expense or benefit. The Company’s reportable segments are strategic businesses that utilize common merchandising, distribution and marketing functions, as well as common information systems and corporate administration. All inter-segment sales prices are market based. Each segment is managed separately because of the differences in required infrastructure and the difference in products and services:2019:
Three Months Ended August 31, 2019 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||
Total revenues | $ | 1,515,805 | $ | 4,714,682 | $ | 265,662 | $ | 1,122,751 | $ | - | $ | 7,618,900 | ||||||||||||
Intersegment revenues | (1,321 | ) | (232,309 | ) | - | - | - | (233,630 | ) | |||||||||||||||
Revenue from external customers | 1,514,484 | 4,482,373 | 265,662 | 1,122,751 | - | 7,385,270 | ||||||||||||||||||
Segment profit (loss) | 828,978 | 955,360 | 7,979 | 296,880 | (841,434 | ) | 1,247,763 | |||||||||||||||||
Total assets | 1,445,041 | 11,838,237 | 1,005,356 | 5,620,012 | 9,377,697 | 29,286,343 | ||||||||||||||||||
Capital expenditures | (2,040 | ) | 162,127 | 23,106 | 1,673 | 12,570 | 197,436 | |||||||||||||||||
Total depreciation & amortization | $ | 10,353 | $ | 151,848 | $ | 2,533 | $ | 185,208 | $ | 22,891 | $ | 372,833 |
Three Months Ended August 31, 2018 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||
Total revenues | $ | 1,470,486 | $ | 5,032,787 | $ | 298,359 | $ | 1,250,905 | $ | - | $ | 8,052,537 | ||||||||||||
Intersegment revenues | (1,732 | ) | (250,717 | ) | - | - | - | (252,449 | ) | |||||||||||||||
Revenue from external customers | 1,468,754 | 4,782,070 | 298,359 | 1,250,905 | - | 7,800,088 | ||||||||||||||||||
Segment profit (loss) | 693,383 | 1,070,613 | (120,262 | ) | 229,818 | (847,923 | ) | 1,025,629 | ||||||||||||||||
Total assets | 1,199,536 | 13,332,652 | 1,011,649 | 5,920,971 | 6,065,406 | 27,530,214 | ||||||||||||||||||
Capital expenditures | 6 | 61,152 | 1,734 | 9,966 | 39,502 | 112,360 | ||||||||||||||||||
Total depreciation & amortization | $ | 11,631 | $ | 142,697 | $ | 11,179 | $ | 241,033 | $ | 28,409 | $ | 434,949 |
Six Months Ended August 31, 2019 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||
Total revenues | $ | 2,944,846 | $ | 10,581,154 | $ | 498,081 | $ | 2,282,556 | $ | - | $ | 16,306,637 | ||||||||||||
Intersegment revenues | (2,607 | ) | (492,761 | ) | - | - | - | (495,368 | ) | |||||||||||||||
Revenue from external customers | 2,942,239 | 10,088,393 | 498,081 | 2,282,556 | - | 15,811,269 | ||||||||||||||||||
Segment profit (loss) | 1,446,888 | 2,124,047 | (7,033 | ) | 576,043 | (1,948,398 | ) | 2,191,547 | ||||||||||||||||
Total assets | 1,445,041 | 11,838,237 | 1,005,356 | 5,620,012 | 9,377,697 | 29,286,343 | ||||||||||||||||||
Capital expenditures | 8,500 | 385,679 | 32,624 | 1,673 | 52,508 | 480,984 | ||||||||||||||||||
Total depreciation & amortization | $ | 21,183 | $ | 301,980 | $ | 5,143 | $ | 375,977 | $ | 46,203 | $ | 750,486 |
May 31, 2020 | February 29, 2020 | |||||||
Ingredients and supplies | $ | 2,355,461 | $ | 2,186,652 | ||||
Finished candy | 2,034,297 | 1,827,767 | ||||||
U-Swirl food and packaging | 42,086 | 56,708 | ||||||
Reserve for slow moving inventory | (291,017 | ) | (320,149 | ) | ||||
Total inventories | $ | 4,140,827 | $ | 3,750,978 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
Six Months Ended August 31, 2018 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||
Total revenues | $ | 2,783,691 | $ | 10,903,302 | $ | 659,794 | $ | 2,384,159 | $ | - | $ | 16,730,946 | ||||||||||||
Intersegment revenues | (2,767 | ) | (562,006 | ) | - | - | - | (564,773 | ) | |||||||||||||||
Revenue from external customers | 2,780,924 | 10,341,296 | 659,794 | 2,384,159 | - | 16,166,173 | ||||||||||||||||||
Segment profit (loss) | 1,182,654 | 2,239,948 | (198,756 | ) | 364,973 | (1,798,016 | ) | 1,790,803 | ||||||||||||||||
Total assets | 1,199,536 | 13,332,652 | 1,011,649 | 5,920,971 | 6,065,406 | 27,530,214 | ||||||||||||||||||
Capital expenditures | 3,535 | 172,917 | 3,805 | 13,304 | 48,871 | 242,432 | ||||||||||||||||||
Total depreciation & amortization | $ | 23,556 | $ | 283,724 | $ | 23,854 | $ | 485,084 | $ | 56,236 | $ | 872,454 |
Revenue from one customer of the Company’s Manufacturing segment represented approximately $1.5 million, or 9.3 percent, of the Company’s revenues from external customers during the six months ended August 31, 2019, compared to $1.4 million, or 8.8 percent, of the Company’s revenues from external customers during the six months ended August 31, 2018.
NOTE 8 – GOODWILL AND INTANGIBLE ASSETS
Intangible assets consist of the following:
August 31, 2019 | February 28, 2019 | ||||||||||||||||||||
Amortization Period (Years) | Gross Carrying Value | Accumulated Amortization | Gross Carrying Value | Accumulated Amortization | |||||||||||||||||
Intangible assets subject to amortization | |||||||||||||||||||||
Store design | 10 | $ | 220,778 | $ | 214,903 | $ | 220,778 | $ | 214,152 | ||||||||||||
Packaging licenses | 3 | - | 5 | 120,830 | 120,830 | 120,830 | 120,830 | ||||||||||||||
Packaging design | 10 | 430,973 | 430,973 | 430,973 | 430,973 | ||||||||||||||||
Trademark/Non-competition agreements | 5 | - | 20 | 715,339 | 260,349 | 715,339 | 223,628 | ||||||||||||||
Franchise rights | 20 | 5,979,637 | 2,616,333 | 5,979,637 | 2,300,717 | ||||||||||||||||
Total | $ | 7,467,557 | $ | 3,643,388 | $ | 7,467,557 | $ | 3,290,300 | |||||||||||||
Intangible assets not subject to amortization | |||||||||||||||||||||
Franchising segment- | |||||||||||||||||||||
Company stores goodwill | $ | 832,308 | $ | 832,308 | |||||||||||||||||
Franchising goodwill | 97,318 | 97,318 | |||||||||||||||||||
Manufacturing segment-goodwill | 97,318 | 97,318 | |||||||||||||||||||
Trademark | 20,000 | 20,000 | |||||||||||||||||||
Total goodwill | 1,046,944 | 1,046,944 | |||||||||||||||||||
Total Intangible Assets | $ | 8,514,501 | $ | 3,643,388 | $ | 8,514,501 | $ | 3,290,300 |
Amortization expense related to intangible assets totaled $353,088 and $422,573 during the six months ended August 31, 2019 and 2018, respectively.
At August 31, 2019, annual amortization of intangible assets, based upon the Company’s existing intangible assets and current useful lives, is estimated to be the following:
2020 | 353,088 | |||
2021 | 594,229 | |||
2022 | 490,060 | |||
2023 | 411,607 | |||
2024 | 345,642 | |||
Thereafter | 1,629,543 | |||
Total | $ | 3,824,169 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 – COSTS ASSOCIATED WITH COMPANY-OWNED STORE CLOSURES
Costs associated with Company-owned store closures were the result of closing certain underperforming Company-owned locations during the three and six months ended August 31, 2018. Costs associated with Company-owned store closures of $118,793 and $176,981 were incurred during the three and the six months ended August 31, 2018, respectively.
There were no comparable costs incurred during the three and six months ended August 31, 2019.
NOTE 10 – NOTE PAYABLE
The Company’s long-term debt is comprised of a promissory note, the proceeds of which were loaned to SWRL and used to finance SWRL’s business acquisitions. The promissory note matures on January 15, 2020.
As of August 31, 2019 and February 28, 2019, notes payable consisted of the following:
August 31, 2019 | February 28, 2019 | |||||||
Promissory note | $ | 480,445 | $ | 1,176,488 | ||||
Less: current maturities | (480,445 | ) | (1,176,488 | ) | ||||
Long-term obligations | $ | - | $ | - |
NOTE 11 – LEASING ARRANGEMENTS6 - PROPERTY AND EQUIPMENT, NET
The Company conducts its retail operations in facilities leased under non-cancelable operating leases of up to ten years. Certain leases contain renewal options for between fiveProperty and ten additional yearsequipment at increased monthly rentals. SomeMay 31, 2020 and February 29, 2020 consisted of the leases provide for contingent rentals based on sales in excess of predetermined base levels.following:
May 31, 2020 | February 29, 2020 | |||||||
Land | $ | 513,618 | $ | 513,618 | ||||
Building | 5,031,395 | 5,031,395 | ||||||
Machinery and equipment | 10,470,117 | 10,664,396 | ||||||
Furniture and fixtures | 805,139 | 852,557 | ||||||
Leasehold improvements | 985,407 | 1,154,396 | ||||||
Transportation equipment | 440,989 | 440,989 | ||||||
18,246,665 | 18,657,351 | |||||||
Less accumulated depreciation | (12,543,081 | ) | (12,719,338 | ) | ||||
Property and equipment, net | $ | 5,703,584 | $ | 5,938,013 |
The Company acts as primary lessee of some franchised store premises, whichDepreciation expense related to property and equipment totaled $194,557 and $201,110 during the Company then subleases to franchisees, but the majority of existing locations are leased by the franchisee directly.three months ended May 31, 2020 and 2019, respectively.
NOTE 7 – GOODWILL AND INTANGIBLE ASSETS
In some instances,Intangible assets at May 31, 2020 and February 28, 2020 consist of the Company has leased space for its Company-owned locations that are now occupied by franchisees. When the Company-owned location was sold or transferred, the store was subleased to the franchisee who is responsible for the monthly rent and other obligations under the lease.following:
The Company also leases trucking equipment and warehouse space in support of its manufacturing operations. Expense associated with trucking and warehouse leases is included in cost of sales on the consolidated statements of income.
May 31, 2020 | February 29, 2020 | |||||||||||||||||||
Amortization | Gross Carrying | Accumulated | Gross Carrying | Accumulated | ||||||||||||||||
Intangible assets subject to amortization | ||||||||||||||||||||
Store design |
| 10 | $ | 394,826 | $ | 216,027 | $ | 295,779 | $ | 215,653 | ||||||||||
Packaging licenses | 3 | - | 5 | 120,830 | 120,830 | 120,830 | 120,830 | |||||||||||||
Packaging design |
| 10 | 430,973 | 430,973 | 430,973 | 430,973 | ||||||||||||||
Trademark/Non-competition agreements | 5 | - | 20 | 556,339 | 313,274 | 715,339 | 297,072 | |||||||||||||
Franchise rights |
| 20 | 5,979,637 | 3,063,930 | 5,979,637 | 2,931,949 | ||||||||||||||
Total | 7,482,605 | 4,145,034 | 7,542,558 | 3,996,477 | ||||||||||||||||
Intangible assets not subject to amortization | ||||||||||||||||||||
Franchising segment- | ||||||||||||||||||||
Company stores goodwill | $ | 515,065 | $ | 832,308 | ||||||||||||||||
Franchising goodwill | 97,318 | 97,318 | ||||||||||||||||||
Manufacturing segment-goodwill | 97,318 | 97,318 | ||||||||||||||||||
Trademark | 20,000 | 20,000 | ||||||||||||||||||
Total goodwill | 729,701 | 1,046,944 | ||||||||||||||||||
Total Intangible Assets | $ | 8,212,306 | $ | 4,145,034 | $ | 8,589,502 | $ | 3,996,477 |
ASU 2016-02 allows, as a practical expedient, the retention of the classification of existing leases as operating or financing. All of the Company’s leases are classified as operating leases and that classification has been retained upon adoption. The Company does not believe the utilization of this practical expedient has a material impact on lease classifications.
The Company accounts for paymentsAmortization expense related to lease liabilities on a straight-line basis overintangible assets totaled $148,557 and $176,544 during the lease term. Lease expense recognized for the sixthree months ended AugustMay 31, 20192020 and 2018 in the Consolidated Statements of Income was $478,707 and $522,181,2019, respectively.
The amountAt May 31, 2020, annual amortization of the ‘Right of Use Asset’ and ‘Lease Liability’ recordedplaced in the Consolidated Balance Sheetsservice intangible assets, based upon the adoption of ASU 2016-02 was $3.3 million. The lease liability reflects the present value of the Company’s estimated future minimum lease payments over the life of its leases. This includes known escalationsexisting intangible assets and renewal option periods reasonably assured of being exercised. Typically, renewal options are considered reasonably assured of being exercised if the sales performance of the location remains strong. Therefore, the ‘Right of Use Asset’ and ‘Lease Liability’ include an assumption on renewal options that have not yet been exercised by the Company, and are not currently a future obligation. The Company has separated non-lease components from lease components in the recognition of the ‘Right of Use Asset’ and ‘Lease Liability’ except in instances where such costs were not practical to separate. To the extent that occupancy costs, such as site maintenance, are included in the ‘Right of Use Asset’ and ‘Lease Liability,’ the impactcurrent useful lives, is immaterial. For franchised locations, the related occupancy costs including property taxes, insurance and site maintenance are generally requiredestimated to be paid by the franchisees as part of the franchise arrangement. In addition, the Company is the lessee under non-store related leases such as storage facilities and trucking equipment. For leases where the implicit rate is not readily determinable, the Company uses an incremental borrowing rate to calculate the lease liability that represents an estimate of the interest rate the Company would incur to borrow on a collateralized basis over the term of a lease. The weighted average discount rate used for operating leases was 3.4% as of August 31, 2019. The total estimated future minimum lease payments is $3.4 million.following:
FYE 21 | $ | 417,509 | ||
FYE 22 | 466,554 | |||
FYE 23 | 391,988 | |||
FYE 24 | 329,267 | |||
FYE 25 | 277,022 | |||
Thereafter | 1,281,184 | |||
Total | $ | 3,163,524 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
During FY 2020, the Company initiated a store design project. The initiative is expected to add approximately $250,000 of intangible assets, of which, $174,000 was recorded as of May 31, 2020. This amount will be subject to amortization upon conclusion of the project.
NOTE 8 – IMPAIRMENT OF LONG-LIVED AND INTANGIBLE ASSETS
We assess the potential impairment of our long-lived assets on an annual basis or whenever events or changes in circumstances indicate the carrying value of the assets or asset group may not be recoverable. Due to the significant impact of the COVID-19 pandemic on our operations, we determined it was necessary to perform an interim test of our long-lived assets during the three months ended May 31, 2020. Based on the results of these assessments, we recorded $545,000 of expense. This expense is presented within general and administrative expense on the Consolidated Statements of Operations.
The assessment of our goodwill, trademark and long lived asset fair values includes many assuptions that are subject to risk and uncertainties. The primary assumptions, which are all Level 3 inputs of the fair value hierarchy (inputs to the valuation methodology that are unobservable and significant to the fair value measurement), used in our impairment testing consist of:
● | Expected future cash flows from operation of our Company-owned units. |
● | Forecasted future royalty revenue, marketing revenue and associated expenses. |
● | Projected rate of royalty savings on trademarks. |
● | Our cost of capital. |
As of May 31, 2020 costs associated with the impairment of long-lived and intangible assets consist of the following:
Company store goodwill impairment | $ | 317,243 | ||
Trademark intangible asset impairment | 159,000 | |||
Company-owned store impairment of long-lived assets and inventory | 68,558 | |||
Total | $ | 544,801 |
Certain interim tests did not indicate a need for impairment. Franchise rights, store design, manufacturing segment goodwill and franchising goodwill tests succeeded during the interim period. We believe we have made reasonable estimates and judgements, however, further COVID-19 related impacts could cause interim testing to be performed in future periods and further impairments recorded if testing of impairment is not successful in future periods.
NOTE 9 – LINE OF CREDIT AND LONG-TERM DEBT
The Company has a $5.0 million credit line for general corporate and working capital purposes. On March 16, 2020, as a precautionary measure in light of the COVID-19 pandemic and the related economic impacts, the Company drew the maximum amount available on the credit line in an amount equal to $3.4 million (the full amount of $5.0 million under the credit line, subject to the borrowing base of 50% of eligible accounts receivable plus 50% of eligible inventories). The credit line is secured by substantially all of the Company’s assets, except retail store assets. Interest on borrowings is at LIBOR plus 2.25% (2.4% at May 31, 2020). Additionally, the line of credit is subject to various financial ratio and leverage covenants. At May 31, 2020, the Company was not compliant with a covenant of the line of credit that requires the Company to have $1.5 million of adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the trailing twelve months ended May 31, 2020. As a result of COVID-19, the Company failed to meet the amount of EBITDA required by this covenant. On June 26, 2020 Wells Fargo Bank, NA (“Wells Fargo”) delivered to the Company a Reservation of Rights Letter (“Bank Letter”). The Bank Letter reserved all rights available to Wells Fargo under the Credit Agreement dated October 30, 2015 including, but not limited to, the right of Wells Fargo to demand immediate payment of all amounts outstanding under the Credit Agreement. The letter also placed restrictions on the Company’s ability to draw any further funds on the Line of Credit. The Company intends to work with Wells Fargo to amend the associated covenants as the trends related to COVID-19 begin become clear. There is no assurance that Wells Fargo will agree to any proposed amendment. The credit line is subject to renewal in September 2021 and the Company believes it is likely to be renewed on terms similar to the current terms, subject to the Company’s recovery from the impacts of COVID-19.
The Company’s long-term debt is comprised of promissory notes pursuant to the Paycheck Protection Program, under the recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the U.S. Small Business Administration (the “SBA Loans”). The Company received total proceeds of $1.5 million from the SBA Loans. The SBA Loans are scheduled to mature in April 2022 and have a 1.00% interest rate, and are subject to the terms and conditions applicable to loans administered by the U.S. Small Business Administration under the CARES Act. The SBA Loans may be prepaid by the Company at any time prior to maturity with no prepayment penalties. As of May 31, 2020 the Company is in compliance with all provisions related to the SBA Loans.
The SBA Loans contains customary events of default relating to, among other things, payment defaults and breaches of representations and warranties. Subject to certain conditions, the SBA Loans may be forgiven in whole or in part by applying for forgiveness pursuant to the CARES Act and the PPP. The amount of loan proceeds eligible for forgiveness is based on a formula based on a number of factors, including the amount of loan proceeds used by the Company during the period after the loan origination for certain purposes, including payroll costs, interest on certain mortgage obligations, rent payments on certain leases, and certain qualified utility payments, provided that, among other things, at least 60-75% of the loan amount is used for eligible payroll costs, the employer maintaining or rehiring employees and maintaining salaries at certain level. In accordance with the requirements of the CARES Act and the PPP, the Company intends to use the proceeds from the SBA Loans for qualifying expenses. No assurance can be given that the Company will be granted forgiveness of the SBA Loans in whole or in part. As of May 31, 2020 the Company had recorded approximately $3,200 of interest expense payable relate to the SBA Loans.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
As of AugustMay 31, 2020 and February 28, 2020, notes payable consisted of the following:
May 31, 2020 | February 29, 2020 | |||||||
Paycheck protection program note payable in monthly installments of principal and interest at 1.0% per annum through April 2022 | $ | 1,538,424 | $ | - | ||||
Less: current maturities | (590,377 | ) | - | |||||
Long-term obligations | $ | 948,047 | $ | - |
NOTE 10 - STOCKHOLDERS’ EQUITY
Cash Dividend
The Company paid a quarterly cash dividend of $0.12 per common share on March 15, 2019 maturitiesto stockholders of lease liabilities forrecord on March 5, 2019. The Company paid a quarterly cash dividend of $0.12 per share of common stock on June 14, 2019 to stockholders of record on June 4, 2019. The Company paid a quarterly cash dividend of $0.12 per share of common stock on September 13, 2019 to stockholders of record on September 4, 2019. The Company paid a quarterly cash dividend of $0.12 per share of common stock on December 6, 2019 to stockholders of record on November 22, 2019. The Company paid a quarterly cash dividend of $0.12 per share of common stock on March 13, 2020 to stockholders of record on February 28, 2020.
Future declarations of dividends will depend on, among other things, the Company's results of operations, financial condition, capital requirements, and on such other factors as the Company's Board of Directors may in its discretion consider relevant and in the best long-term interest of the Company’s operating leases were as follows:stockholders.
FY 20 | $ | 416,147 | ||
FY 21 | 819,004 | |||
FY 22 | 694,755 | |||
FY 23 | 437,446 | |||
FY 24 | 315,963 | |||
Thereafter | 717,039 | |||
Total | $ | 3,400,354 | ||
Less: imputed interest | (333,528 | ) | ||
Present value of lease liabilities: | $ | 3,066,826 | ||
Weighted average lease term (years) | 7.0 |
As previously announced on May 11, 2020, the Board of Directors suspended the Company’s first quarter cash dividend payment to preserve cash and provide additional flexibility in the current environment as a result of the economic impact of COVID-19. Furthermore, the Board of Directors has suspended future quarterly dividends until the significant uncertainty of the current public health crisis and global economic climate has passed, and the Board of Directors determines that resumption of dividend payments is in the best interest of the Company and its stockholders.
DuringStock Repurchases
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three months ended AugustMay 31, 2020 or 2019. As of May 31, 2020, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
Warrants
In consideration of Edible entering into the exclusive supplier agreement and the performance of its obligations therein, on December 20, 2019, the Company entered intoissued Edible a lease amendmentwarrant (the “Warrant”) to extendpurchase up to 960,677 shares of the termCompany’s common stock (the “Warrant Shares”) at an exercise price of a lease for a Company-owned location. This lease amendment resulted$8.76 per share. The Warrant Shares vest in annual tranches in varying amounts following each contract year under the Company recognizing a present valueexclusive supplier agreement, subject to, and only upon, Edible’s achievement of future lease liability of $476,611 based upon a total lease liability of $532,811.
NOTE 12 –REVENUE FROM CONTRACTS WITH CUSTOMERS
Effective March 1, 2018,certain revenue thresholds on an annual or cumulative five-year basis in connection with its performance under the Company adopted ASC 606. ASC 606 provides that revenues are to be recognized when control of promised goods or services is transferred to a customer in an amount that reflectsexclusive supplier agreement. The Warrant expires six months after the consideration expected to be received for those goods or services. This new standard does not impact the Company's recognitionfinal and conclusive determination of revenue from sales of confectionary items tothresholds for the Company’s franchiseesfifth contract year and others, orthe cumulative revenue determination in its Company-owned stores as those sales are recognized ataccordance with the timeterms of the underlying sale and are presented net of sales taxes and discounts. The standard also does not change the recognition of royalties and marketing fees from franchised or licensed locations, which are based on a percent of sales and recognized at the time the sales occur. The standard does change the timing in which the Company recognizes initial fees from franchisees and licensees for new franchise locations and renewals that affect the term of the franchise agreement.
Initial Franchise Fees, License Fees, Transfer Fees and Renewal FeesWarrant.
The Company's policy for recognizing initial franchise and renewal fees through February 28, 2018 was to recognize initial franchise fees upon new store openings and renewalsCompany determined that impact the termgrant date fair value of the franchise agreement upon renewal. In accordance with the new guidance, the initial franchise services arewarrants was de minimis and did not distinct from the continuing rights or services offered during the termrecord any amount in consideration of the franchise agreement, and will be treated as a single performance obligation. Beginning March 1, 2018, initial franchise fees are being recognized as the Company satisfies the performance obligation over the term of the franchise agreement, which is generally 10-15 years.
At August 31, 2019, annual revenue expected to be recognized in the future, related to performance obligations that are not yet fully satisfied, are estimated to be the following:
FY 20 | $ | 117,608 | ||
FY 21 | 188,664 | |||
FY 22 | 175,465 | |||
FY 23 | 162,496 | |||
FY 24 | 131,911 | |||
Thereafter | 439,785 | |||
Total | $ | 1,215,929 |
Gift Cards
The Company’s franchisees sell gift cards, which do not have expiration dates or non-usage fees. The proceeds from the sale of gift cards by the franchisees are accumulated by the Company and paid out to the franchisees upon customer redemption.warrants. The Company has historically accumulated gift card liabilities and has not recognized breakage associated withutilized a Monte Carlo model for purposes of determining the gift card liability. The adoption of ASC 606 requires the use of the “proportionate” method for recognizing breakage, which the Company has not historically utilized. Upon adoption of ASC 606 the Company began recognizing breakage from gift cards when the gift card is redeemed by the customer or the Company determines the likelihood of the gift card being redeemed by the customer is remote (“gift card breakage”). The determination of the gift card breakage rate is based upon Company-specific historical redemption patterns.grant date fair value.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
Stock-Based Compensation
Under the Company’s 2007 Equity Incentive Plan (as amended and restated) (the “2007 Plan”), the Company may authorize and grant stock awards to employees, non-employee directors and certain other eligible participants, including stock options, restricted stock and restricted stock units.
The Company recognized $143,718 of stock-based compensation expense during the three months ended May 31, 2020 compared with $231,254 during the three months ended May 31, 2019. Compensation costs related to stock-based compensation are generally amortized over the vesting period of the stock awards.
The following table summarizes non-vested restricted stock unit transactions for common stock during the three months ended May 31, 2020 and 2019:
Three Months Ended | ||||||||
May 31, | ||||||||
2020 | 2019 | |||||||
Outstanding non-vested restricted stock units as of February 28 or 29: | 265,555 | 25,002 | ||||||
Granted | - | 270,000 | ||||||
Vested | (41,131 | ) | - | |||||
Cancelled/forfeited | - | - | ||||||
Outstanding non-vested restricted stock units as of May 31: | 224,424 | 295,002 | ||||||
Weighted average grant date fair value | $ | 9.39 | $ | 9.62 | ||||
Weighted average remaining vesting period (in years) | 4.33 | 4.94 |
The Company did not issue any unrestricted shares of stock to non-employee directors during the three months ended May 31, 2020 compared to 4,500 shares issued during the three months ended May 31, 2019. In connection with these non-employee director stock issuances, the Company recognized $0 and $42,525 of stock-based compensation expense during the three months ended May 31, 2020 and 2019, respectively.
During the three months ended May 31, 2020, the Company recognized $143,718 of stock-based compensation expense related to non-vested, non-forfeited restricted stock unit grants compared to $188,729 during the three months ended May 31, 2019. The restricted stock units generally vest in equal annual installments over a period of five to six years. Total unrecognized stock-based compensation expense of non-vested, non-forfeited restricted stock units, as of May 31, 2020, was $1,994,662, which is expected to be recognized over the weighted average period of 4.33 years.
During the three months ended May 31, 2019, the Company granted 270,000 shares of restricted stock units with a grant date fair value of $2,536,100 or $9.39 per share, compared with no restricted stock units awarded in the three months ended May 31, 2020. The restricted stock unit grants vest in equal annual installments over a period of five to six years.
The Company has no outstanding stock options as of May 31, 2020.
NOTE 11 - EARNINGS PER SHARE
Basic earnings per share is calculated using the weighted-average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through the settlement of restricted stock units. Restricted stock units become dilutive within the period granted and remain dilutive until the units vest and are issued as common stock.
The weighted-average number of shares outstanding used in the computation of diluted earnings per share does not include outstanding common shares issuable if their effect would be anti-dilutive. During the three months ended May 31, 2020, 960,677 shares of common stock warrants and 209,960 shares of issuable common stock were excluded from the computation of diluted earnings per share because their effect would have been anti-dilutive.
NOTE 1312 – DISAGGREGATION OF REVENUELEASING ARRANGEMENTS
The following table presents disaggregated revenue by methodCompany conducts its retail operations in facilities leased under non-cancelable operating leases of recognitionup to ten years. Certain leases contain renewal options for between five and segment:ten additional years at increased monthly rentals. Some of the leases provide for contingent rentals based on sales in excess of predetermined base levels.
|
|
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Franchise fees | $ | 65,327 | $ | - | $ | - | $ | 16,602 | $ | 81,929 |
|
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Factory sales | - | 4,482,373 | - | - | 4,482,373 | |||||||||||||||
Retail sales | - | - | 265,662 | 636,005 | 901,667 | |||||||||||||||
Royalty and marketing fees | 1,449,157 | - | - | 470,144 | 1,919,301 | |||||||||||||||
Total | $ | 1,514,484 | $ | 4,482,373 | $ | 265,662 | $ | 1,122,751 | $ | 7,385,270 |
|
|
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Franchise fees | $ | 36,005 | $ | - | $ | - | $ | 71,533 | $ | 107,538 |
Revenues recognized at a point in time: | ||||||||||||||||||||
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Factory sales | - | 4,782,070 | - | - | 4,782,070 | |||||||||||||||
Retail sales | - | - | 298,359 | 655,890 | 954,249 | |||||||||||||||
Royalty and marketing fees | 1,432,749 | - | - | 523,482 | 1,956,231 | |||||||||||||||
Total | $ | 1,468,754 | $ | 4,782,070 | $ | 298,359 | $ | 1,250,905 | $ | 7,800,088 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
The Company acts as primary lessee of some franchised store premises, which the Company then subleases to franchisees, but the majority of existing locations are leased by the franchisee directly. Currently, there are not indications that the Company will be required to make any payments on behalf of franchisees. In some instances, the Company has leased space for its Company-owned locations that are now occupied by franchisees. When the Company-owned location was sold or transferred, the store was subleased to the franchisee who is responsible for the monthly rent and other obligations under the lease. The Company also leases trucking equipment and warehouse space in support of its manufacturing operations. Expense associated with trucking and warehouse leases is included in cost of sales on the consolidated statements of operations. ASU 2016-02 allows, as a practical expedient, the retention of the classification of existing leases as operating or financing. All of the Company’s leases are classified as operating leases and that classification has been retained upon adoption. The Company does not believe the utilization of this practical expedient has a material impact on lease classifications. The Company accounts for payments related to lease liabilities on a straight-line basis over the lease term. As of May 31, 2020 and 2019, lease expense recognized in the Consolidated Statements of Income was $212,063 and $238,666, respectively. The amount of the Right of Use Asset and Lease Liability recorded upon the adoption of ASU 2016-02 was $3.3 million. The lease liability reflects the present value of the Company’s estimated future minimum lease payments over the life of its leases. This includes known escalations and renewal option periods reasonably assured of being exercised. Typically, renewal options are considered reasonably assured of being exercised if the sales performance of the location remains strong. Therefore, the Right of Use Asset and Lease Liability include an assumption on renewal options that have not yet been exercised by the Company, and are not currently a future obligation. The Company has separated non-lease components from lease components in the recognition of the Asset and Liability except in instances where such costs were not practical to separate. To the extent that occupancy costs, such as site maintenance, are included in the Asset and Liability, the impact is immaterial. For franchised locations, the related occupancy costs including property taxes, insurance and site maintenance are generally required to be paid by the franchisees as part of the franchise arrangement. In addition, the Company is the lessee under non-store related leases such as storage facilities and trucking equipment. For leases where the implicit rate is not readily determinable, the Company uses an incremental borrowing rate to calculate the lease liability that represents an estimate of the interest rate the Company would incur to borrow on a collateralized basis over the term of a lease. The weighted average discount rate used for operating leases was 3.4% as of May 31, 2020. The total estimated future minimum lease payments is $2.8 million. As of May 31, 2020, maturities of lease liabilities for our operating leases were as follows: |
Revenues recognized over time under ASC 606: | ||||||||||||||||||||
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Franchise fees | $ | 145,346 | $ | - | $ | - | $ | 42,863 | $ | 188,209 |
Revenues recognized at a point in time: | ||||||||||||||||||||
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Factory sales | - | 10,088,393 | - | - | 10,088,393 | |||||||||||||||
Retail sales | - | - | 498,081 | 1,258,177 | 1,756,258 | |||||||||||||||
Royalty and marketing fees | 2,796,893 | - | - | 981,516 | 3,778,409 | |||||||||||||||
Total | $ | 2,942,239 | $ | 10,088,393 | $ | 498,081 | $ | 2,282,556 | $ | 15,811,269 |
|
|
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Franchise fees | $ | 110,521 | $ | - | $ | - | $ | 90,152 | $ | 200,673 |
Revenues recognized at a point in time: | ||||||||||||||||||||
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Factory sales | - | 10,341,296 | - | - | 10,341,296 | |||||||||||||||
Retail sales | - | - | 659,794 | 1,317,278 | 1,977,072 | |||||||||||||||
Royalty and marketing fees | 2,670,403 | - | - | 976,729 | 3,647,132 | |||||||||||||||
Total | $ | 2,780,924 | $ | 10,341,296 | $ | 659,794 | $ | 2,384,159 | $ | 16,166,173 |
FYE 21 | $ | 616,088 | ||
FYE 22 | 694,755 | |||
FYE 23 | 437,445 | |||
FYE 24 | 315,962 | |||
FYE 25 | 164,223 | |||
Thereafter | 552,817 | |||
Total | $ | 2,781,290 | ||
Less: imputed interest | (262,846 | ) | ||
Present value of lease liabilities: | $ | 2,518,444 | ||
Weighted average lease term | 6.7 |
NOTE 13 – COMMITMENTS AND CONTINGENCIES
Purchase contracts
The Company frequently enters into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit the Company to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, the Company may benefit if prices rise during the terms of these contracts, but it may be required to pay above-market prices if prices fall and it is unable to renegotiate the terms of the contract. As of May 31, 2020, the Company was contracted for approximately $227,000 of raw materials under such agreements. The Company has designated these contracts as normal under the normal purchase and sale exception under the accounting standards for derivatives. These contracts are not entered into for speculative purposes.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 – FTD LOSS CONTINGENCY
In June 2019, the Company’s largest customer, FTD Companies, Inc. and its domestic subsidiaries (“FTD”), filed for Chapter 11 bankruptcy proceedings. As a part of such bankruptcy proceedings, divisions of FTD’s business and certain related assets, including the divisions that the Company has historically sold product to, were sold through an auction to multiple buyers.
The Company has historically conducted business with FTD under a Gourmet Foods Supplier Agreement (the “Supplier Agreement”), that among other provisions, provided assurance that custom inventory purchased by the Company and developed specifically for FTD would be purchased by FTD upon termination of the Supplier Agreement. On September 23, 2019, the Company received notice that the bankruptcy court had approved FTD to reject and not enforce the Supplier Agreement as part of the proceedings.
As a result of FTD’s bankruptcy, the sale of certain assets, and the court’s approval to reject and not enforce the terms of the Supplier Agreement, the Company is uncertain if accounts receivable and inventory balances associated with FTD at AugustMay 31, 20192020 will be realized at their full value, or if any revenue will be received from FTD in the future. During FY 2020, the Company recognized an estimated loss of $230,384 associated with inventory specific to FTD as the Company determined that it was probable that a loss on certain inventory would be realized. A potential loss associated with thesethe remaining balances is not probable and/or is not able to be estimated as of the date of these consolidated financial statements.
As of AugustMay 31, 2019,2020, balances associated with FTD consist of the following:
August 31, 2019 | May 31, 2020 | |||||||
Ingredients and supplies | $ | 382,656 | $ | 296,019 | ||||
Finished candy | 76,688 | 20,562 | ||||||
Accounts receivable | 73,232 | 79,744 | ||||||
Reserve for estimated losses | (198,054 | ) | ||||||
Total potential loss, contingent upon the bankruptcy proceedings | $ | 532,576 | $ | 198,271 |
FTD represented approximately $1.5 million,NOTE 15 – INCOME TAXES
Under the recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) a net operating loss (“NOL”) arising during the Company’s fiscal year 2021 can be carried back for five years to offset the Company’s taxable income for fiscal years 2016-2020. This five-year period spans Federal effective tax rates for the Company ranging from 21% to 34%, the result of the Tax Cuts and Jobs Act enacted during the Company’s fiscal year ended February 28, 2018.
The Company’s deferred tax assets are valued at the current federally enacted rate of 21%. If the Company were to continue to realize NOL’s in future periods, or 9.3%,inclur a NOL for all of fiscal year 2021 the loss carryback provisions of the CARES Act may enable the Company to offset taxable income from prior years when federally enacted tax rates were higher than 21%. Under such a scenario, the Company would incur a gain associated with the revaluation of the Company’s revenuesdeferred tax assets to the extent that prior taxable income during periods of higher enacted federal tax rates could be offset by current NOLs.
As of May 31, 2020, no amount has been recorded in anticipation of offsetting prior period’s taxable income with current NOLs as it is not possible for the six months ended August 31, 2019, comparedCompany to $1.4 million, or 8.8%,reasonably estimate the likelihood of such a scenario and the impact if realized.
NOTE 16 - OPERATING SEGMENTS
The Company classifies its business interests into five reportable segments: Franchising, Manufacturing, Retail Stores, U-Swirl and Other. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1 to the Company’s revenues duringconsolidated financial statements included in the six months ended August 31, 2018. FTD represented approximately $3.1 million or 9% of our total revenues duringCompany’s Annual Report on Form 10-K for the year ended February 28, 2019 compared to revenue29, 2020. The Company evaluates performance and allocates resources based on operating contribution, which excludes unallocatedcorporate general and administrative costs and income tax expense or benefit. The Company’s reportable segments are strategic businesses that utilize common merchandising, distribution, and marketing functions, as well as common information systems and corporate administration. All inter-segment sales prices are market based. Each segment is managed separately because of approximately $5.1 million or 13% of our total revenues during the year ended February 28, 2018. Our future results may be adversely impacted by decreasesdifferences in required infrastructure and the purchases of this customer or the loss of this customer entirely.differences in products and services:
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended May 31, 2020 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||
Total revenues | $ | 254,477 | $ | 2,293,093 | $ | 59,981 | $ | 254,047 | $ | - | $ | 2,861,598 | ||||||||||||
Intersegment revenues | (683 | ) | (158,478 | ) | - | - | - | (159,161 | ) | |||||||||||||||
Revenue from external customers | 253,794 | 2,134,615 | 59,981 | 254,047 | - | 2,702,437 | ||||||||||||||||||
Segment profit (loss) | (451,319 | ) | (783,469 | ) | (477,825 | ) | (457,718 | ) | (2,676,394 | ) | (4,846,725 | ) | ||||||||||||
Total assets | 1,090,475 | 10,430,680 | 604,386 | 5,565,436 | 11,417,149 | 29,108,126 | ||||||||||||||||||
Capital expenditures | - | 13,854 | - | 1,712 | 6,922 | 22,488 | ||||||||||||||||||
Total depreciation & amortization | $ | 10,138 | $ | 161,830 | $ | 3,403 | $ | 146,949 | $ | 20,795 | $ | 343,115 |
Three Months Ended May 31, 2019 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||
Total revenues | $ | 1,429,041 | $ | 5,866,472 | $ | 232,419 | $ | 1,159,805 | $ | - | $ | 8,687,737 | ||||||||||||
Intersegment revenues | (1,286 | ) | (260,452 | ) | - | - | - | (261,738 | ) | |||||||||||||||
Revenue from external customers | 1,427,755 | 5,606,020 | 232,419 | 1,159,805 | - | 8,425,999 | ||||||||||||||||||
Segment profit (loss) | 617,910 | 1,168,687 | (15,012 | ) | 279,163 | (1,106,964 | ) | 943,784 | ||||||||||||||||
Total assets | 1,275,471 | 11,660,148 | 992,148 | 6,330,540 | 9,290,136 | 29,548,443 | ||||||||||||||||||
Capital expenditures | 10,540 | 223,552 | 9,518 | - | 39,938 | 283,548 | ||||||||||||||||||
Total depreciation & amortization | $ | 10,830 | $ | 150,132 | $ | 2,611 | $ | 190,769 | $ | 23,312 | $ | 377,654 |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q (“Quarterly Report”) includes statements of our expectations, intentions, plans and beliefs that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are intended to come within the safe harbor protection provided by those sections. These forward-looking statements involve various risks and uncertainties. The nature of our operations and the environment in which we operate subject us to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. The statements, other than statements of historical fact, included in this Quarterly ReportReport are forward-looking statements. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as "will," "intend," "believe," "expect," "anticipate," "should," "plan," "estimate," "potential," or similar expressions. Factors which could cause results to differ include, but are not limited to: the outcomeimpact of the novel coronavirus (COVID-19) on our business, including, among other things, online sales, factory sales, retail sales and royalty and marketing fees, our liquidity, our ongoing evaluationcost cutting and capital preservation measures,achievement of the anticipated potential benefits of the strategic alternatives, including, but not limitedalliance with Edible (as defined herein), our ability to provide products to Edible under the time table for identifying potential transactions or transaction candidates and whether any transaction will be completed, relationships and changes in our customers,strategic alliance,theability to increase our online sales throught the agreements with Edible, changes in the confectionery business environment, seasonality, consumer interest in our products, general economic conditions, the success of our frozen yogurt business, receptiveness of our products internationally, consumer and retail trends, costs and availability of raw materials, competition, the success of our co-branding strategy, the success of international expansion efforts and the effect of government regulations. Government regulations which we and our franchisees and licensees either are, or may be, subject to and which could cause results to differ from forward-looking statements include, but are not limited to: local, state and federal laws regarding health, sanitation, safety, building and fire codes, franchising, licensing, employment, manufacturing, packaging and distribution of food products and motor carriers. For a detailed discussion of the risks and uncertainties that may cause our actual results to differ from the forward-looking statements contained herein, please see the section entitled “Risk Factors” contained in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended February 289, 20120920. Additional factors that might cause such differences include, but are not limited to: the length and severity of the current COVID-19 pandemic and its effect on among other things, factory sales, retail sales, royalty and marketing fees and operations, the effect of any governmental action or mandated employer-paid benefits in response to the COVID-19 pandemic, our ability to manage costs and reduce expenditures in the current economic environment and the availability of additional financing if and when required. These forward-looking statements apply only as of the date of this Quarterly Report.Report. As such they should not be unduly relied upon for more current circumstances. Except as required by law, we undertake no obligation to release publicly any revisions to these forward-looking statements that might reflect events or circumstances occurring after the date of this Quarterly ReportReport or those that might reflect the occurrence of unanticipated events.
Unless otherwise specified, the “Company,” “we,” “us” or “our” refers to Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, and its consolidated subsidiaries(including its operating subsidiary with the same name, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation (“RMCF”)).
Overview
We are an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, we are headquartered in Durango, Colorado and manufacture an extensive line of premium chocolate candies and other confectionery products. Our wholly-owned subsidiary, U-Swirl International, Inc. (“U-Swirl”), franchises and operates soft-serve frozen yogurt cafés. Our revenues and profitability are derived principally from our franchised/license system of retail stores that feature chocolate, frozen yogurt and other confectionary products. We also sell our candy in select locations outside of our system of retail stores and license the use of our brand with certain consumer products. As of AugustMay 31, 2019,2020, there were two Company-owned, 9598 licensee-owned and 242232 franchised Rocky Mountain Chocolate Factory stores operating in 37 states, Canada, South Korea, the republic of Panama, and the Philippines. As of AugustMay 31, 2019,2020, U-Swirl operated fourthree Company-owned cafés and 9283 franchised cafés located in 2425 states and Qatar. U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt”.
Strategic Alliance with Edible Arrangements
On December 20, 2019, the Company entered into a strategic alliance (the “Strategic Alliance”) with Edible Arrangements, LLC (“EA”) and Farids & Co. LLC (“Farids,” and together with EA and any permitted transferees, “Edible”), pursuant to which, among other things, the Company will become the exclusive provider of certain branded chocolate products to Edible, its affiliates and its franchisees. In connection with the Strategic Alliance, the Company entered into a strategic alliance agreement, an exclusive supplier operating agreement and a warrant agreement with Edible. In addition, on March 7, 2020, the Company entered into an ecommerce licensing agreement with Edible, whereby Edible sells a wide variety of chocolates, candies and other confectionery products produced by the Company or its franchisees through Edible’s websites.
Bankruptcy of FTD Companies
In June 2019, the Company’s largest customer, FTD Companies, Inc. and its domestic subsidiaries (“FTD”), filed for Chapter 11 bankruptcy proceedings. As a part of such bankruptcy proceedings, divisions of FTD’s business and certain related assets, including the divisions that the Company has historically sold product to, were sold through the auction to multiple buyers. The Company is uncertain if accounts receivable and inventory balances associated with FTD at AugustMay 31, 20192020 will be realized at their full value, or if any revenue will be received from FTD in the future. See Note 13 to the financial statements contained herein for additional information about the FTD bankruptcy.
the novel coronavirus (COVID-19), including the vast mandated self-quarantines and closures of non-essential business throughout the United States and internationally. Nearly all of the Company-owned and franchise stores have been directly and negatively impacted by public health measures taken in response to COVID-19, with nearly all locations experiencing reduced operations as a result of, among other things, modified business hours and store and mall closures. As a result, franchisees and licensees are not ordering products for their stores in line with historical amounts. This trend has negatively impacted, and is expected to continue to negatively impact, among other things, factory sales, retail sales and royalty and marketing fees. Beginning in May 2020 most stores previously closed for much of March 2020 and April 2020 in response to COVID-19 began to re-open. Most stores re-opened subject to various local health restrictions and reduced operations. It is unclear when or if store operations will return to pre COVID-19 levels.
In addition, as previously announced on May 11, 2020, the Board of Directors decided to suspend the Company’s first quarter cash dividend payment to preserve cash and provide additional flexibility in the current environment impacted by the COVID-19 pandemic. Furthermore, the Board of Directors has suspended future quarterly dividends until the significant uncertainty of the current public health crisis and economic climate has passed, and the Board of Directors determines that resumption of dividend payments is in the best interest of us and our stockholders.
During this challenging time, the Company’s foremost priority is the safety and well-being of our employees, customers, franchisees and communities. In addition to the already stringent practices for the quality and safety of the Company’s confections, the Company is diligently following health and safety guidance issued by the World Health Organization, the Centers for Disease Control and state and local governmental agencies. COVID-19 has had an unprecedented impact on the retail industry as containment measures continue to impact the Company’s operations and the retail industry. Numerous countries, states and local governments have effected ordinances to protect the public through social distancing, which has caused, and we expect will continue to cause, a significant decrease in, among other things, retail traffic and as a result, factory sales, retail sales and royalty and marketing fees. With that said, Rocky Mountain Chocolate Factory products remain available for sale online. The Company’s current focus is on supporting its franchisees and licensees during this challenging time and driving growth in online sales, especially in light of the ecommerce licensing agreement with Edible, as discussed below, while also sensibly managing costs. The number of Company-owned and franchise stores remaining open may change frequently and significantly due to the ever-changing nature of the COVID-19 outbreak.
In these challenging and unprecedented times, management is taking all necessary and appropriate action to maximize liquidity as the Company navigates the current landscape. These actions include significantly reducing operating expenses and production volume to reflect reduced sales volumes as well as the elimination of all non-essential spending and capital expenditures. Further, in an abundance of caution and to maintain ample financial flexibility, the Company drew down the full amount under our line of credit and the Company received a loan under the Paycheck Protection Program (the “PPP”). The receipt of funds under the PPP has allowed the Company to temporarily avoid workforce reduction measures amidst a steep decline in revenue and production volume. While the Company believes it has sufficient liquidity with its current cash position, the Company will continue to monitor and evaluate all financing alternatives as necessary as these unprecedented events evolve. For more information, please see Item 1A “Risk Factors—The Novel Coronavirus (COVID-19) Pandemic Has, and May Continue to, Materially and Adversely Affect our Sales, Earnings, Financial Condition and Liquidity” in our Annual Report on Form 10-K as filed on May 29, 2020 with the United States Securities and Exchange Commission.
Results of Operations
Three Months Ended AugustMay 31, 20120920 Compared to the Three Months Ended AugustMay 31, 20189
Results Summary
Basic earnings per share increased 15.4%decreased from $0.13 in$0.12 per share for the three months ended AugustMay 31, 20182019 to $0.15 ina net loss of $(0.61) per share for the three months ended AugustMay 31, 2019.2020. Revenues decreased (5.3)%67.9% from $7.8$8.43 million infor the three months ended AugustMay 31, 20182019 to $7.4$2.70 million infor the three months ended AugustMay 31, 2019.2020. Operating income increased 19.7%decreased from $1.0 million in$946,000 for the three months ended AugustMay 31, 20182019 to $1.2an operating loss of $(4.83) million infor the three months ended AugustMay 31, 2019.2020. Net income increased 22.3%decreased from $751,000 in$712,000 for the three months ended AugustMay 31, 20182019 to $918,000 ina net loss of $(3.67) million for the three months ended AugustMay 31, 2019.2020. The increasedecrease in revenue, operating income and net income was due primarily to lower operating expenses in the three months ended August 31, 2019 compared toimpacts from the three months ended August 31, 2018.
RevenuesCOVID-19 pandemic, including its impact on our operation and the operations of our franchised, licensed and Company-owned locations.
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 4,482.4 | $ | 4,782.1 | $ | (299.7 | ) | (6.3 | )% | |||||||
Retail sales | 901.7 | 954.3 | (52.6 | ) | (5.5 | )% | ||||||||||
Franchise fees | 81.9 | 107.5 | (25.6 | ) | (23.8 | )% | ||||||||||
Royalty and marketing fees | 1,919.3 | 1,956.2 | (36.9 | ) | (1.9 | )% | ||||||||||
Total | $ | 7,385.3 | $ | 7,800.1 | $ | (414.8 | ) | (5.3 | )% |
Revenues
Three Months Ended | ||||||||||||||||
($'s in thousands) | May 31, | $ | % | |||||||||||||
| 2020 | 2019 | Change | Change | ||||||||||||
Factory sales | $ | 2,134.6 | $ | 5,606.0 | $ | (3,471.4 | ) | (61.9 | )% | |||||||
Retail sales | 187.6 | 854.6 | (667.0 | ) | (78.0 | )% | ||||||||||
Franchise fees | 55.0 | 106.3 | (51.3 | ) | (48.3 | )% | ||||||||||
Royalty and marketing fees | 325.2 | 1,859.1 | (1,533.9 | ) | (82.5 | )% | ||||||||||
Total | $ | 2,702.4 | $ | 8,426.0 | $ | (5,723.6 | ) | (67.9 | )% |
Factory Sales
The decrease in factory sales for the three months ended AugustMay 31, 2019 versus2020 compared to the three months ended AugustMay 31, 20182019 was primarily due to a 32.4%73.6% decrease in sales of product to our network of franchised and licensed retail stores and a 30.5% decrease in shipments of product to customers outside our network of franchise and licensedfranchised retail locations and a 2.7% decrease in purchases by our network of franchised and licensed stores. The decrease in shipments of product to customers outside our network of franchise and licensed retail stores was primarily the result of product rationalization and a decline in revenue associated with products no longer offered for sale. Purchases by the Company’s largest customer FTD, decreased during the three months ended AugustMay 31, 2019, with revenue from such customer decreasing2020 were approximately $144,000, or 5.3% of the Company’s revenues, compared to approximately $103,000,$1.4 million, or 1.4%,16.3% of the Company’s revenues during the three months ended AugustMay 31, 2019 compared to $144,000, or 1.8% of the Company’s revenues during the three months ended August 31, 2018.for this same customer. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company will realize any revenue from FTD in the future, and if so, whether such revenues will return to historic levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise The decrease in sales of product to our network of franchised and license locations decreased 5.0%licensed retail stores was primarily the result of the COVID-19 pandemic and the associated public health measures in place during the three months ended AugustMay 31, 2019, compared2020, which significantly reduced traffic in our stores. These decreases were partially offset by increases in factory sales associated with the three months ended August 31, 2018. our strategic alliance with Edibile and by an increase in revenue from online sales of our products directly to consumers. Beginning in May 2020 most stores previously closed for much of March 2020 and April 2020, in response to COVID-19, began to re-open. Most stores re-opened subject to various local health restrictions and reduced operations. It is unclear when or if store operations will return to pre COVID-19 levels.
Retail Sales
The decrease in retailRetail sales at Company-owned stores decreased for the three months ended AugustMay 31, 20192020 compared to the three months ended AugustMay 31, 2018 was primarily due to fewer Company-owned units in operation because2019 as a result of the closure of certain underperforming Company-owned locations during the prior fiscal year. Same store sales at all of our Company-owned stores and cafés decreased 1.7% infor much of the three months ended AugustMay 31, 2019 compared to2020. The closure of our Company-owned stores was the result of the COVID-19 pandemic and the associated public health measures in place during the three months ended AugustMay 31, 2018.2020. As of May 31, 2020 all but one Company-owned store had resumed limited operations following COVID-19 related closure.
Royalties,Royalty, Marketing Fees and Franchise Fees
The decrease in royaltiesroyalty and marketing fees fromfor the three months ended AugustMay 31, 20182020 compared to the three months ended AugustMay 31, 2019 was primarily due to a 6.5% decreasethe COVID-19 pandemic and the associated public health measures in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 291 in the three months ended August 31, 2018 to 272place during the three months ended AugustMay 31, 2019. This decrease is the result2020. Nearly all of domestic store closures exceeding domestic store openings. Same store sales at total franchise storesour franchised locations experienced reduced operations and cafés in operation increased 0.1%periods of full closure during the three months ended AugustMay 31, 20192020.
The decrease in franchise fees for the three months ended May 31, 2020 compared to the three months ended AugustMay 31, 2018.
The decrease in franchise fee revenue for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 was the result of a decrease in revenue resulting from fewer franchise stores in operationstore closures and the termination of any future contract liability associated recognition of revenue overwith the term of the franchise agreement.closure.
Costs and Expenses
Cost of Sales
Three Months Ended | Three Months Ended | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
August 31, | $ | % | May 31, | $ | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(
Gross Margin
Adjusted Gross Margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider
Cost of Salesand Gross Margin
Factory gross margins decreased Retail gross margins decreased from 66.3% during the three months ended May 31, 2019 Franchise Costs
The decrease in franchise costs in the
Sales and Marketing
The decrease in sales and marketing costs for the
General and Administrative
The increase in general and administrative costs for the
Retail Operating Expenses
The decrease in retail operating expenses for the
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was
Other Income (Expense)
Income Tax Expense
Our effective income tax rate was 24.3% for the
Liquidity and Capital Resources
As discussed below, we have taken several defensive measures to maximize liquidity in response to the COVID-19 pandemic, including the suspension of As of May 31,
Cash and cash equivalent balances increased
During the
Financing activities provided cash of $4,236,021 for the three months ended May 31, 2020, primarily as a as a result of the use of the line of credit and receipt of loans under the Paycheck Protection Program, as described below. In comparison, financing activitied used cash of
The Company has a $5.0 million
On
The SBA Loans contains customary events of default relating to, among other things, payment defaults and breaches of representations and warranties. Subject to certain conditions, the SBA Loans may be forgiven in whole or in part by applying for forgiveness pursuant to the CARES Act and the PPP. The amount of loan proceeds eligible for forgiveness is based on a formula based on a number of factors, including the amount of loan proceeds used by the Company during the eight-week period after the loan origination for certain purposes, including payroll costs, interest on certain mortgage obligations, rent payments on certain leases, and certain qualified utility payments, provided that, among other things, at least 75% of the loan amount is used for eligible payroll costs, the employer maintaining or rehiring employees and maintaining salaries at certain level. In accordance with the requirements of the CARES Act and the PPP, the Company intends to use the proceeds from the SBA Loans primarily for payroll costs. No assurance can be given that the Company will be granted forgiveness of the SBA Loans in whole or in part.
Off-Balance Sheet Arrangements
Purchase obligations: As of
Impact of Inflation
Inflationary factors such as increases in the costs of ingredients and labor directly affect our operations. Most of our leases provide for cost-of-living adjustments and require us to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, our future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on increased costs to our customers.
Depreciation expense is based on the historical cost to us of
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and the summer vacation season. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of our business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February
Issuer Purchases of Equity Securities
None.
Not
None.
____________________________
* Filed herewith. ** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. (Registrant)
29 | 2019 | 2018 | Change | Change | 2020 | 2019 | Change | Change | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cost of sales - factory | $ | 3,435.3 | $ | 3,575.4 | $ | (140.1 | ) | (3.9 | )% | $ | 2,790.6 | $ | 4,326.5 | $ | (1,535.9 | ) | (35.5 | )% | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cost of sales - retail | 303.1 | 308.5 | (5.4 | ) | (1.8 | )% | 92.6 | 288.2 | (195.6 | ) | (67.9 | )% | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Franchise costs | 441.6 | 582.8 | (141.2 | ) | (24.2 | )% | 421.2 | 483.0 | (61.8 | ) | (12.8 | )% | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Sales and marketing | 434.8 | 565.2 | (130.4 | ) | (23.1 | )% | 474.1 | 556.7 | (82.6 | ) | (14.8 | )% | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
General and administrative | 830.5 | 813.4 | 17.1 | 2.1 | % | 3,179.5 | 1,144.7 | 2,034.8 | 177.8 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Retail operating | 469.3 | 498.9 | (29.6 | ) | (5.9 | )% | 319.2 | 448.9 | (129.7 | ) | (28.9 | )% | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total | $ | 5,914.6 | $ | 6,344.2 | $ | (429.6 | ) | (6.8 | )% | $ | 7,277.2 | $ | 7,248.0 | $ | 29.2 | 0.4 | % |
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
May 31, | $ | % | ||||||||||||||
($'s in thousands) | 2020 | 2019 | Change | Change | ||||||||||||
Factory gross margin | $ | (656.0 | ) | $ | 1,279.5 | $ | (1,935.5 | ) | (151.3 | )% | ||||||
Retail gross margin | 95.0 | 566.4 | (471.4 | ) | (83.2 | )% | ||||||||||
Total | $ | (561.0 | ) | $ | 1,845.9 | $ | (2,406.9 | ) | (130.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Three Months Ended | ||||||||||||||||
May 31, | % | % | ||||||||||||||
2020 | 2019 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | -30.7 | % | 22.8 | % | (53.5 | )% | (234.6 | )% | ||||||||
Retail gross margin | 50.6 | % | 66.3 | % | (15.7 | )% | (23.7 | )% | ||||||||
Total | -24.2 | % | 28.6 | % | (52.8 | )% | (184.6 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Three Months Ended | ||||||||||||||||
May 31, | $ | % | ||||||||||||||
($'s in thousands) | 2020 | 2019 | Change | Change | ||||||||||||
Factory gross margin | $ | (656.0 | ) | $ | 1,279.5 | $ | (1,935.5 | ) | (151.3 | )% | ||||||
Plus: depreciation and amortization | 157.5 | 145.7 | 11.8 | 8.1 | % | |||||||||||
Factory adjusted gross margin | (498.5 | ) | 1,425.2 | (1,923.7 | ) | (135.0 | )% | |||||||||
Retail gross margin | 95.0 | 566.4 | (471.4 | ) | (83.2 | )% | ||||||||||
Total Adjusted Gross Margin | $ | (403.5 | ) | $ | 1,991.6 | $ | (2,395.1 | ) | (120.3 | )% | ||||||
Factory adjusted gross margin | -23.4 | % | 25.4 | % | (48.8 | )% | (192.1 | )% | ||||||||
Retail gross margin | 50.6 | % | 66.3 | % | (15.7 | )% | (23.7 | )% | ||||||||
Total Adjusted Gross Margin | -17.4 | % | 30.8 | % | (48.2 | )% | (156.5 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 190 basis points in the three months ended August 31, 2019 compared to the three months ended August 31, 2018 because of a charge associated with costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production for the three months ended August 31, 2019 compared to the three months ended August 31, 2018. The decrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 2019 compared to the prior year.
Franchise Costs
The decrease in franchise costs in the three months ended August 31, 2019 versus the three months ended August 31, 2018 is due primarily to a decrease in legal and professional expense in the three months ended August 31, 2019 compared to the three months ended August 31, 2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to planned cost reductions as a result of fewer domestic franchise units in operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The increase in general and administrative costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses increased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 52.3% in the three months ended August 31, 2018 to 52.0% in the three months ended August 31, 2019. This decrease is primarily the result of the change in units in operation from the prior year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation. See Note 8 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7% from $138,000 in the three months ended August 31, 2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Costs Associated with Company-Owned Store Closures
There was $119,000 in costs associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no costs associated with company-owned store closures incurred during the three months ended August 31, 2019. The costs incurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest income was $3,000 in the three months ended August 31, 2019 compared to net interest expense of $15,000 incurred in the three months ended August 31, 2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 2019 was 26.4%, compared to 26.8% for the three months ended August 31, 2018.
Six Months Ended August 31, 2019 Compared to the Six Months Ended August 31, 2018
Results Summary
Basic earnings per share increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018. Revenues decreased (2.2)% to $15.8 million for the six months ended August 31, 2019 compared to $16.2 million in the six months ended August 31, 2018. Operating income increased 20.2% from $1.8 million in the six months ended August 31, 2018 to $2.2 million in the six months ended August 31, 2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018 to $1.6 million in the six months ended August 31, 2019. The increase in operating income and net income was due primarily to lower operating expenses in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 2019 versus the six months ended August 31, 2018 was primarily due to a 10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. The decrease in shipments of product to customers outside our network of franchise and licensed retail stores was primarily the result of product rationalization and a decline in revenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, FTD, were approximately $1.5 million, or 9.3%, of the Company’s revenues during the six months ended August 31, 2019, compared to $1.4 million, or 8.8% of the Company’s revenues during the six months ended August 31, 2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company will realize any revenue from FTD in the future, and if so, whether such revenues will return to historic levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 5.3% in the six months ended August 31, 2019, compared with the six months ended August 31, 2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to fewer Company-owned units in operation because of the closure of certain underperforming Company-owned locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés increased 0.2% in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Royalties, Marketing Fees and Franchise Fees
The increase in royalties and marketing fees from the six months ended August 31, 2018 to the six months ended August 31, 2019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 6.5% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 293 in the six months ended August 31, 2018 to 274 during the six months ended August 31, 2019. This decrease is the result of domestic store closures exceeding domestic store openings. Same store sales at total franchise stores and cafés in operation increased 0.5% during the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was the result of a decrease in revenue resulting from fewer franchise stores in operation and the associated recognition of revenue over the term of the franchise agreement.
Costs and Expenses
Cost of Sales
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider itthem in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Salesand Gross Margin
Factory gross margins decreased 110 basis pointsto negative gross margin of (23.4)% in the sixthree months ended AugustMay 31, 2020 compared to positive gross margin of 25.4% during the three months ended May 31, 2019, due primarily to lower production volume in the three months ended May 31, 2020 compared to the sixthree months ended AugustMay 31, 2018 because2019. During the three monthd ended May 31, 2020, production volume decreased 56.7% in response to a 61.9% decrease in factory sales, primarily due to the impacts of the COVID-19 pandemic. As a charge associated with costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6%the decrease in production forvolume, factory fixed costs, including idle labor, exceeded revenue during the sixthree months ended AugustMay 31, 2020. During the three months ended May 31, 2020 the Company incurred approximately $280,000 of production labor costs associated with paying employees who abided by local stay at home orders related to COVID-19 public health measures. This excess capacity cost, in the form of idle labor, was included in cost of sales.
Retail gross margins decreased from 66.3% during the three months ended May 31, 2019 compared to 50.6% during the sixthree months ended AugustMay 31, 2018.2020. The increasedecrease in retail gross margins was primarily the result of the temporary closure of underperformingall of our Company-owned locations duringstores for much of the prior fiscal year.three months ended May 31, 2020 due to the COVID-19 pandemic, and the associated impact on perishable inventory.
Franchise Costs
The decrease in franchise costs in the sixthree months ended AugustMay 31, 2020 compared to the three months ended May 31, 2019 versus the six months ended August 31, 2018 iswas due primarily to a decrease in legal and professional expenses.lower travel costs, the result of COVID-19 related travel restrictions. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreasedincreased to 23.3%90.3% in the sixthree months ended AugustMay 31, 20192020 from 28.0%24.6% in the sixthree months ended AugustMay 31, 2018.2019. This decreaseincrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise costs.royalty revenues.
Sales and Marketing
The decrease in sales and marketing costs for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 2018 is2019 was primarily due to planned cost reductions as a result of fewer domestic franchise unitslower advertising and promotion costs, partially offset by an increase in operation.online advertising cost.
General and Administrative
The increase in general and administrative costs for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 2018 is2019 was due primarily due to an increase in bad debt expense, the impairment of certain intangible assets and higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the six months ended August 31, 2018.fees. As a percentage of total revenues, general and administrative expenses increased to 12.5%117.7% in the sixthree months ended AugustMay 31, 20192020 compared to 10.7%13.6% in the sixthree months ended AugustMay 31, 2018.2019. Bad debt expense was primarily the result of management’s assessment of the likelihood of collecting accounts and notes receivable as of May 31, 2020. As a result of this assessment total allowances for potentially uncollectable accounts and notes receivable increased to $2,108,912 at May 31, 2020, compared to $557,916 at February 29, 2020. This cost was a direct result of public health measures in place due to responses to COVID-19 and the financial burden experienced by the majority of our network of franchised and licensed locations. See Note 8 to the financial statements for a summary of costs associated with the impairment of certain intangible assets.
Retail Operating Expenses
The decrease in retail operating expenses for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 20182019 was due primarily to changes in units in operation, as a resultthe temporary closure of all of our Company-owned stores for much of the three months ended May 31, 2020. The closure of certain underperformingour Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 53.7% in the six months ended August 31, 2018 to 52.3% in the six months ended August 31, 2019. This decrease is primarilystores was the result of COVID-19 and the changeassociated public health measures in units in operation fromplace during the prior year.three months ended May 31, 2020.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $457,000$186,000 in the sixthree months ended AugustMay 31, 2019,2020, a decrease of 23.5%20.0% from $598,000$232,000 incurred in the sixthree months ended AugustMay 31, 2018.2019. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation.operation and lower amortization of the associated franchise rights. See Note 87 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7%8.1% from $275,000$145,700 in the sixthree months ended AugustMay 31, 20182019 to $293,000$157,500 in the sixthree months ended AugustMay 31, 2019.2020. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.service.
Costs Associated with Company-Owned Store Closures
There was $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2019. The costs incurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Interest income was approximately equal toNet interest expense was $17,800 in the sixthree months ended AugustMay 31, 2019,2020 compared to net interest expense of $33,000 in$2,200 during the sixthree months ended AugustMay 31, 2018.2019. This decrease in interest expense is due to lower average outstanding promissory note balances forchange was primarily the sixresult of the Company’s increased debt as a result of measures taken during the three months ended AugustMay 31, 2019.2020 to ensure adequate liquidity during the COVID-19 pandemic. During the three months ended May 31, 2020, the Company borrowed $3.4 million from its line of credit and borrowed $1.5 million of loans under the Paychecks Protection Program.
Income Tax Expense
Our effective income tax rate was 24.3% for the sixthree months ended AugustMay 31, 20192020 and was 25.6%, compared to 25.9%24.6% for the sixthree months ended AugustMay 31, 2018. 2019.
Liquidity and Capital Resources
As discussed below, we have taken several defensive measures to maximize liquidity in response to the COVID-19 pandemic, including the suspension of Augustour cash dividend, reducing expenses, extending payment terms with vendors, reducing production volume and deferring discretionary capital expenditures. Based on these actions, we believe that cash flows from operations and our cash and cash equivalents on hand, will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additional future financing may be necessary to fund our operations, and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all, especially in light of the market volatility and uncertainty as a result of the COVID-19 pandemic. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, in each case, in light of the market volatility and uncertainty as a result of the COVID-19 pandemic, among other factors, could impact our business and liquidity.
As of May 31, 2019 and February 28, 2019,2020, working capital was $9.5$5.1 million, compared to $8.0 million as of February 29, 2020, a decrease of $2.9 million. The decrease in working capital was primarily due to an increase in current liabilities, the result of the Company’s response to COVID-19 and measures taken to ensure sufficient short-term liquidity.
Cash and cash equivalent balances increased approximately $400,000 to $5.8$2.6 million as of August 31, 2019 compared to $5.4from $4.8 million as of February 28, 2019,29, 2020 to $7.4 million as of May 31, 2020, primarily as a result of cash flow generated by operating activities exceeding cash flow used by financing activities, including repaymentthe use of debtthe line of credit and paymentreceipt of dividends.loans under the Paycheck Protection Program, as described below. Our current ratio was 2.91.5 to 1 at AugustMay 31, 20192020 compared to 3.02.4 to 1 at February 28, 2019.29, 2020. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the sixthree months ended AugustMay 31, 2019, we had net income of $1,629,697. Operating2020, operating activities providedused cash of $2,902,679, with$1,598,042, primarily the principal adjustment to reconcileresult of operating results, the net income to net cash provided by operating activities beingprovision for loss on accounts and notes receivable of $1,468,815, asset impairment and store closure losses of $544,060, depreciation and amortization of $750,486$343,115, an increase in accounts payble of $680,748 and the expense recorded for stockrelated to stock-based compensation of $386,670.$143,718. During the comparable 2018 period, we had net income of $1,327,759, andthree months ended May 31, 2019, operating activities provided cash of $1,388,429. The principal adjustment to reconcile$1,828,109, primarily the net income to net cash provided byresult of operating activities wasresults, depreciation and amortization of $872,454$377,654, a decrease in inventories of $344,058 and the increase in inventoryexpense related to stock-based compensation of $1,579,686. $231,254.
DuringFor the sixthree months ended AugustMay 31, 2019,2020, investing activities used cash of $406,376,$46,127, primarily due to the purchases of property and equipment and intangible assets of $480,984.$63,952. In comparison, investing activities used cash of $200,537$254,836 during the sixthree months ended AugustMay 31, 20182019, primarily due to the purchase of property and equipment of $242,432.$283,548.
Financing activities provided cash of $4,236,021 for the three months ended May 31, 2020, primarily as a as a result of the use of the line of credit and receipt of loans under the Paycheck Protection Program, as described below. In comparison, financing activitied used cash of $2,127,121 for$1,061,726 during the sixthree months ended AugustMay 31, 2019, primarily due to dividend payments and used cash of $2,087,641payments on debt during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.three months ended May 31, 2019.
We haveRevolving Credit Line
The Company has a $5.0 million ($5.0 million available as of August 31, 2019)credit line for general corporate and working capital purposes. On March 16, 2020, as a precautionary measure in light of the COVID-19 pandemic and the related economic impacts, the Company drew the maximum amount available on the credit line in an amount equal to $3.4 million (the full amount of $5.0 million under the credit collateralizedline, subject to the borrowing base of 50% of eligible accounts receivable plus 50% of eligible inventories). The credit line is secured by substantially all of ourthe Company’s assets, with the exception of ourexcept retail store assets. Interest on borrowings is at LIBOR plus 2.25% (2.4% at May 31, 2020). Additionally, the line of credit is subject to various financial ratio and leverage covenants. AsAt May 31, 2020, the Company was not compliant with a covenant of August 31, 2019, we were in compliance with all such covenants. Thethe line of credit was renewed in September 2019that requires the Company to have $1.5 million of adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the trailing twelve months ended May 31, 2020. As a result of COVID-19, the Company failed to meet the amount of EBITDA required by this covenant. On June 26, 2020 Wells Fargo Bank, NA (“Wells Fargo”) delivered to the Company a Reservation of Rights Letter (“Bank Letter”). The Bank Letter reserved all rights available to Wells Fargo under the Credit Agreement dated October 30, 2015 including, but not limited to, the right of Wells Fargo to demand immediate payment of all amounts outstanding under the Credit Agreement. The letter also placed restrictions on the Company’s ability to draw any further funds on the Line of Credit. The Company intends to work with Wells Fargo to amend the associated covenants as the trends related to COVID-19 begin become clear. There is no assurance that Wells Fargo will agree to any proposed amendment. The credit line is subject to renewal again in September 2021. As2021 and the Company believes it is likely to be renewed on terms similar to the current terms, subject to the Company’s recovery from the impacts of August 31, 2019, no amount was outstanding under this line of credit.COVID-19.
Our outstanding long-term debt is comprised of a promissory note used to finance business acquisitions of SWRL (unpaid balance as of August 31, 2019 of $480,000). The promissory note allowed us to borrow up to a maximum of $7.0 million to finance business acquisitions and bears interest at a fixed annual rate of 3.75%. The promissory note matures on January 15, 2020. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of August 31, 2019, we were in compliance with all such covenants.PPP Loan
On July 15, 2014, we publicly announcedApril 13, 2020 and April 20, 2020, the Company entered into a planLoan Agreements and Promissory Notes (collectively, the “SBA Loans”) with 1st SOURCE BANK pursuant to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stockPaycheck Protection Program (the “PPP”) under the repurchase plan,recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the U.S. Small Business Administration. The Company received total proceeds of $1.5 million from the SBA Loans. The SBA Loans are scheduled to mature on May 21, 2015, we announcedApril 14 and April 20, 2022 and have a further increase1.00% interest rate and are subject to the repurchase planterms and conditions applicable to loans administered by authorizing the purchase of up to an additional $2,090,000 of our common stockU.S. Small Business Administration under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2019. As of August 31, 2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generatedCARES Act. The SBA Loan may be prepaid by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of creditat any time prior to help meet these requirements.maturity with no prepayment penalties.
The SBA Loans contains customary events of default relating to, among other things, payment defaults and breaches of representations and warranties. Subject to certain conditions, the SBA Loans may be forgiven in whole or in part by applying for forgiveness pursuant to the CARES Act and the PPP. The amount of loan proceeds eligible for forgiveness is based on a formula based on a number of factors, including the amount of loan proceeds used by the Company during the eight-week period after the loan origination for certain purposes, including payroll costs, interest on certain mortgage obligations, rent payments on certain leases, and certain qualified utility payments, provided that, among other things, at least 75% of the loan amount is used for eligible payroll costs, the employer maintaining or rehiring employees and maintaining salaries at certain level. In accordance with the requirements of the CARES Act and the PPP, the Company intends to use the proceeds from the SBA Loans primarily for payroll costs. No assurance can be given that the Company will be granted forgiveness of the SBA Loans in whole or in part.
Off-Balance Sheet Arrangements
As of August 31, 2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of AugustMay 31, 2019,2020, we had purchase obligations of approximately $714,000.$227,000. These purchase obligations primarily consist of contractual obligations for future purchases of commodities for use in our manufacturing.
Impact of Inflation
Inflationary factors such as increases in the costs of ingredients and labor directly affect our operations. Most of our leases provide for cost-of-living adjustments and require us to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, our future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on increased costs to our customers.
Depreciation expense is based on the historical cost to us of our fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years will ultimately have to be replaced at higher prices, it is expected that replacement will be a gradual process over many years.
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and the summer vacation season. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of our business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year.
Quantitative and Qualitative Disclosures |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However,As a smaller reporting company, we are exposednot required to some commodity price and interest rate risks.provide the information required by this Item.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of AugustMay 31, 2019.2020.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended AugustMay 31, 20192020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2019.29, 2020. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2019.29, 2020.
Unregistered Sales of Equity Securities and Use of Proceeds |
Issuer Purchases of Equity Securities
None.None
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.applicable.
Other Information |
None.
Exhibits |
3.1 |
|
3.2 |
| |
10.2 |
32.1** | Certification Furnished Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002. |
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Executive Officer, | ||
Chief Financial Officer, Treasurer and |
2019
2018
Change
Change
2020
2019
Change
Change
Factory gross margin
Plus: depreciation and amortization
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 190 basis points in the three months ended August 31, 2019 compared to the three months ended August 31, 2018 because of a charge associated with costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production for the three months ended August 31, 2019 compared to the three months ended August 31, 2018. The decrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 2019 compared to the prior year.
Franchise Costs
The decrease in franchise costs in the three months ended August 31, 2019 versus the three months ended August 31, 2018 is due primarily to a decrease in legal and professional expense in the three months ended August 31, 2019 compared to the three months ended August 31, 2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to planned cost reductions as a result of fewer domestic franchise units in operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The increase in general and administrative costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses increased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 52.3% in the three months ended August 31, 2018 to 52.0% in the three months ended August 31, 2019. This decrease is primarily the result of the change in units in operation from the prior year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation. See Note 8 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7% from $138,000 in the three months ended August 31, 2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Costs Associated with Company-Owned Store Closures
There was $119,000 in costs associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no costs associated with company-owned store closures incurred during the three months ended August 31, 2019. The costs incurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest income was $3,000 in the three months ended August 31, 2019 compared to net interest expense of $15,000 incurred in the three months ended August 31, 2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 2019 was 26.4%, compared to 26.8% for the three months ended August 31, 2018.
Six Months Ended August 31, 2019 Compared to the Six Months Ended August 31, 2018
Results Summary
Basic earnings per share increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018. Revenues decreased (2.2)% to $15.8 million for the six months ended August 31, 2019 compared to $16.2 million in the six months ended August 31, 2018. Operating income increased 20.2% from $1.8 million in the six months ended August 31, 2018 to $2.2 million in the six months ended August 31, 2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018 to $1.6 million in the six months ended August 31, 2019. The increase in operating income and net income was due primarily to lower operating expenses in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 2019 versus the six months ended August 31, 2018 was primarily due to a 10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. The decrease in shipments of product to customers outside our network of franchise and licensed retail stores was primarily the result of product rationalization and a decline in revenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, FTD, were approximately $1.5 million, or 9.3%, of the Company’s revenues during the six months ended August 31, 2019, compared to $1.4 million, or 8.8% of the Company’s revenues during the six months ended August 31, 2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company will realize any revenue from FTD in the future, and if so, whether such revenues will return to historic levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 5.3% in the six months ended August 31, 2019, compared with the six months ended August 31, 2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to fewer Company-owned units in operation because of the closure of certain underperforming Company-owned locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés increased 0.2% in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Royalties, Marketing Fees and Franchise Fees
The increase in royalties and marketing fees from the six months ended August 31, 2018 to the six months ended August 31, 2019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 6.5% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 293 in the six months ended August 31, 2018 to 274 during the six months ended August 31, 2019. This decrease is the result of domestic store closures exceeding domestic store openings. Same store sales at total franchise stores and cafés in operation increased 0.5% during the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was the result of a decrease in revenue resulting from fewer franchise stores in operation and the associated recognition of revenue over the term of the franchise agreement.
Costs and Expenses
Cost of Sales
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider itthem in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Salesand Gross Margin
Factory gross margins decreased 110 basis pointsto negative gross margin of (23.4)% in the sixthree months ended AugustMay 31, 2020 compared to positive gross margin of 25.4% during the three months ended May 31, 2019, due primarily to lower production volume in the three months ended May 31, 2020 compared to the sixthree months ended AugustMay 31, 2018 because2019. During the three monthd ended May 31, 2020, production volume decreased 56.7% in response to a 61.9% decrease in factory sales, primarily due to the impacts of the COVID-19 pandemic. As a charge associated with costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6%the decrease in production forvolume, factory fixed costs, including idle labor, exceeded revenue during the sixthree months ended AugustMay 31, 2020. During the three months ended May 31, 2020 the Company incurred approximately $280,000 of production labor costs associated with paying employees who abided by local stay at home orders related to COVID-19 public health measures. This excess capacity cost, in the form of idle labor, was included in cost of sales.
Retail gross margins decreased from 66.3% during the three months ended May 31, 2019 compared to 50.6% during the sixthree months ended AugustMay 31, 2018.2020. The increasedecrease in retail gross margins was primarily the result of the temporary closure of underperformingall of our Company-owned locations duringstores for much of the prior fiscal year.three months ended May 31, 2020 due to the COVID-19 pandemic, and the associated impact on perishable inventory.
Franchise Costs
The decrease in franchise costs in the sixthree months ended AugustMay 31, 2020 compared to the three months ended May 31, 2019 versus the six months ended August 31, 2018 iswas due primarily to a decrease in legal and professional expenses.lower travel costs, the result of COVID-19 related travel restrictions. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreasedincreased to 23.3%90.3% in the sixthree months ended AugustMay 31, 20192020 from 28.0%24.6% in the sixthree months ended AugustMay 31, 2018.2019. This decreaseincrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise costs.royalty revenues.
Sales and Marketing
The decrease in sales and marketing costs for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 2018 is2019 was primarily due to planned cost reductions as a result of fewer domestic franchise unitslower advertising and promotion costs, partially offset by an increase in operation.online advertising cost.
General and Administrative
The increase in general and administrative costs for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 2018 is2019 was due primarily due to an increase in bad debt expense, the impairment of certain intangible assets and higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the six months ended August 31, 2018.fees. As a percentage of total revenues, general and administrative expenses increased to 12.5%117.7% in the sixthree months ended AugustMay 31, 20192020 compared to 10.7%13.6% in the sixthree months ended AugustMay 31, 2018.2019. Bad debt expense was primarily the result of management’s assessment of the likelihood of collecting accounts and notes receivable as of May 31, 2020. As a result of this assessment total allowances for potentially uncollectable accounts and notes receivable increased to $2,108,912 at May 31, 2020, compared to $557,916 at February 29, 2020. This cost was a direct result of public health measures in place due to responses to COVID-19 and the financial burden experienced by the majority of our network of franchised and licensed locations. See Note 8 to the financial statements for a summary of costs associated with the impairment of certain intangible assets.
Retail Operating Expenses
The decrease in retail operating expenses for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 20182019 was due primarily to changes in units in operation, as a resultthe temporary closure of all of our Company-owned stores for much of the three months ended May 31, 2020. The closure of certain underperformingour Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 53.7% in the six months ended August 31, 2018 to 52.3% in the six months ended August 31, 2019. This decrease is primarilystores was the result of COVID-19 and the changeassociated public health measures in units in operation fromplace during the prior year.three months ended May 31, 2020.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $457,000$186,000 in the sixthree months ended AugustMay 31, 2019,2020, a decrease of 23.5%20.0% from $598,000$232,000 incurred in the sixthree months ended AugustMay 31, 2018.2019. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation.operation and lower amortization of the associated franchise rights. See Note 87 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7%8.1% from $275,000$145,700 in the sixthree months ended AugustMay 31, 20182019 to $293,000$157,500 in the sixthree months ended AugustMay 31, 2019.2020. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.service.
Costs Associated with Company-Owned Store Closures
There was $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2019. The costs incurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Interest income was approximately equal toNet interest expense was $17,800 in the sixthree months ended AugustMay 31, 2019,2020 compared to net interest expense of $33,000 in$2,200 during the sixthree months ended AugustMay 31, 2018.2019. This decrease in interest expense is due to lower average outstanding promissory note balances forchange was primarily the sixresult of the Company’s increased debt as a result of measures taken during the three months ended AugustMay 31, 2019.2020 to ensure adequate liquidity during the COVID-19 pandemic. During the three months ended May 31, 2020, the Company borrowed $3.4 million from its line of credit and borrowed $1.5 million of loans under the Paychecks Protection Program.
Income Tax Expense
Our effective income tax rate was 24.3% for the sixthree months ended AugustMay 31, 20192020 and was 25.6%, compared to 25.9%24.6% for the sixthree months ended AugustMay 31, 2018. 2019.
Liquidity and Capital Resources
As discussed below, we have taken several defensive measures to maximize liquidity in response to the COVID-19 pandemic, including the suspension of Augustour cash dividend, reducing expenses, extending payment terms with vendors, reducing production volume and deferring discretionary capital expenditures. Based on these actions, we believe that cash flows from operations and our cash and cash equivalents on hand, will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additional future financing may be necessary to fund our operations, and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all, especially in light of the market volatility and uncertainty as a result of the COVID-19 pandemic. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, in each case, in light of the market volatility and uncertainty as a result of the COVID-19 pandemic, among other factors, could impact our business and liquidity.
As of May 31, 2019 and February 28, 2019,2020, working capital was $9.5$5.1 million, compared to $8.0 million as of February 29, 2020, a decrease of $2.9 million. The decrease in working capital was primarily due to an increase in current liabilities, the result of the Company’s response to COVID-19 and measures taken to ensure sufficient short-term liquidity.
Cash and cash equivalent balances increased approximately $400,000 to $5.8$2.6 million as of August 31, 2019 compared to $5.4from $4.8 million as of February 28, 2019,29, 2020 to $7.4 million as of May 31, 2020, primarily as a result of cash flow generated by operating activities exceeding cash flow used by financing activities, including repaymentthe use of debtthe line of credit and paymentreceipt of dividends.loans under the Paycheck Protection Program, as described below. Our current ratio was 2.91.5 to 1 at AugustMay 31, 20192020 compared to 3.02.4 to 1 at February 28, 2019.29, 2020. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the sixthree months ended AugustMay 31, 2019, we had net income of $1,629,697. Operating2020, operating activities providedused cash of $2,902,679, with$1,598,042, primarily the principal adjustment to reconcileresult of operating results, the net income to net cash provided by operating activities beingprovision for loss on accounts and notes receivable of $1,468,815, asset impairment and store closure losses of $544,060, depreciation and amortization of $750,486$343,115, an increase in accounts payble of $680,748 and the expense recorded for stockrelated to stock-based compensation of $386,670.$143,718. During the comparable 2018 period, we had net income of $1,327,759, andthree months ended May 31, 2019, operating activities provided cash of $1,388,429. The principal adjustment to reconcile$1,828,109, primarily the net income to net cash provided byresult of operating activities wasresults, depreciation and amortization of $872,454$377,654, a decrease in inventories of $344,058 and the increase in inventoryexpense related to stock-based compensation of $1,579,686. $231,254.
DuringFor the sixthree months ended AugustMay 31, 2019,2020, investing activities used cash of $406,376,$46,127, primarily due to the purchases of property and equipment and intangible assets of $480,984.$63,952. In comparison, investing activities used cash of $200,537$254,836 during the sixthree months ended AugustMay 31, 20182019, primarily due to the purchase of property and equipment of $242,432.$283,548.
Financing activities provided cash of $4,236,021 for the three months ended May 31, 2020, primarily as a as a result of the use of the line of credit and receipt of loans under the Paycheck Protection Program, as described below. In comparison, financing activitied used cash of $2,127,121 for$1,061,726 during the sixthree months ended AugustMay 31, 2019, primarily due to dividend payments and used cash of $2,087,641payments on debt during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.three months ended May 31, 2019.
We haveRevolving Credit Line
The Company has a $5.0 million ($5.0 million available as of August 31, 2019)credit line for general corporate and working capital purposes. On March 16, 2020, as a precautionary measure in light of the COVID-19 pandemic and the related economic impacts, the Company drew the maximum amount available on the credit line in an amount equal to $3.4 million (the full amount of $5.0 million under the credit collateralizedline, subject to the borrowing base of 50% of eligible accounts receivable plus 50% of eligible inventories). The credit line is secured by substantially all of ourthe Company’s assets, with the exception of ourexcept retail store assets. Interest on borrowings is at LIBOR plus 2.25% (2.4% at May 31, 2020). Additionally, the line of credit is subject to various financial ratio and leverage covenants. AsAt May 31, 2020, the Company was not compliant with a covenant of August 31, 2019, we were in compliance with all such covenants. Thethe line of credit was renewed in September 2019that requires the Company to have $1.5 million of adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the trailing twelve months ended May 31, 2020. As a result of COVID-19, the Company failed to meet the amount of EBITDA required by this covenant. On June 26, 2020 Wells Fargo Bank, NA (“Wells Fargo”) delivered to the Company a Reservation of Rights Letter (“Bank Letter”). The Bank Letter reserved all rights available to Wells Fargo under the Credit Agreement dated October 30, 2015 including, but not limited to, the right of Wells Fargo to demand immediate payment of all amounts outstanding under the Credit Agreement. The letter also placed restrictions on the Company’s ability to draw any further funds on the Line of Credit. The Company intends to work with Wells Fargo to amend the associated covenants as the trends related to COVID-19 begin become clear. There is no assurance that Wells Fargo will agree to any proposed amendment. The credit line is subject to renewal again in September 2021. As2021 and the Company believes it is likely to be renewed on terms similar to the current terms, subject to the Company’s recovery from the impacts of August 31, 2019, no amount was outstanding under this line of credit.COVID-19.
Our outstanding long-term debt is comprised of a promissory note used to finance business acquisitions of SWRL (unpaid balance as of August 31, 2019 of $480,000). The promissory note allowed us to borrow up to a maximum of $7.0 million to finance business acquisitions and bears interest at a fixed annual rate of 3.75%. The promissory note matures on January 15, 2020. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of August 31, 2019, we were in compliance with all such covenants.PPP Loan
On July 15, 2014, we publicly announcedApril 13, 2020 and April 20, 2020, the Company entered into a planLoan Agreements and Promissory Notes (collectively, the “SBA Loans”) with 1st SOURCE BANK pursuant to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stockPaycheck Protection Program (the “PPP”) under the repurchase plan,recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the U.S. Small Business Administration. The Company received total proceeds of $1.5 million from the SBA Loans. The SBA Loans are scheduled to mature on May 21, 2015, we announcedApril 14 and April 20, 2022 and have a further increase1.00% interest rate and are subject to the repurchase planterms and conditions applicable to loans administered by authorizing the purchase of up to an additional $2,090,000 of our common stockU.S. Small Business Administration under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2019. As of August 31, 2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generatedCARES Act. The SBA Loan may be prepaid by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of creditat any time prior to help meet these requirements.maturity with no prepayment penalties.
The SBA Loans contains customary events of default relating to, among other things, payment defaults and breaches of representations and warranties. Subject to certain conditions, the SBA Loans may be forgiven in whole or in part by applying for forgiveness pursuant to the CARES Act and the PPP. The amount of loan proceeds eligible for forgiveness is based on a formula based on a number of factors, including the amount of loan proceeds used by the Company during the eight-week period after the loan origination for certain purposes, including payroll costs, interest on certain mortgage obligations, rent payments on certain leases, and certain qualified utility payments, provided that, among other things, at least 75% of the loan amount is used for eligible payroll costs, the employer maintaining or rehiring employees and maintaining salaries at certain level. In accordance with the requirements of the CARES Act and the PPP, the Company intends to use the proceeds from the SBA Loans primarily for payroll costs. No assurance can be given that the Company will be granted forgiveness of the SBA Loans in whole or in part.
Off-Balance Sheet Arrangements
As of August 31, 2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of AugustMay 31, 2019,2020, we had purchase obligations of approximately $714,000.$227,000. These purchase obligations primarily consist of contractual obligations for future purchases of commodities for use in our manufacturing.
Impact of Inflation
Inflationary factors such as increases in the costs of ingredients and labor directly affect our operations. Most of our leases provide for cost-of-living adjustments and require us to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, our future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on increased costs to our customers.
Depreciation expense is based on the historical cost to us of our fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years will ultimately have to be replaced at higher prices, it is expected that replacement will be a gradual process over many years.
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and the summer vacation season. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of our business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year.
Quantitative and Qualitative Disclosures |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However,As a smaller reporting company, we are exposednot required to some commodity price and interest rate risks.provide the information required by this Item.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of AugustMay 31, 2019.2020.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended AugustMay 31, 20192020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2019.29, 2020. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2019.29, 2020.
Unregistered Sales of Equity Securities and Use of Proceeds |
Issuer Purchases of Equity Securities
None.None
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.applicable.
Other Information |
None.
Exhibits |
3.1 |
|
3.2 |
| |
10.2 |
32.1** | Certification Furnished Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002. |
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Executive Officer, | ||
Chief Financial Officer, Treasurer and |
2019
2018
Change
Change
2020
2019
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
May 31, | $ | % | ||||||||||||||
($'s in thousands) | 2020 | 2019 | Change | Change | ||||||||||||
Factory gross margin | $ | (656.0 | ) | $ | 1,279.5 | $ | (1,935.5 | ) | (151.3 | )% | ||||||
Retail gross margin | 95.0 | 566.4 | (471.4 | ) | (83.2 | )% | ||||||||||
Total | $ | (561.0 | ) | $ | 1,845.9 | $ | (2,406.9 | ) | (130.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Three Months Ended | ||||||||||||||||
May 31, | % | % | ||||||||||||||
2020 | 2019 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | -30.7 | % | 22.8 | % | (53.5 | )% | (234.6 | )% | ||||||||
Retail gross margin | 50.6 | % | 66.3 | % | (15.7 | )% | (23.7 | )% | ||||||||
Total | -24.2 | % | 28.6 | % | (52.8 | )% | (184.6 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Three Months Ended | ||||||||||||||||
May 31, | $ | % | ||||||||||||||
($'s in thousands) | 2020 | 2019 | Change | Change | ||||||||||||
Factory gross margin | $ | (656.0 | ) | $ | 1,279.5 | $ | (1,935.5 | ) | (151.3 | )% | ||||||
Plus: depreciation and amortization | 157.5 | 145.7 | 11.8 | 8.1 | % | |||||||||||
Factory adjusted gross margin | (498.5 | ) | 1,425.2 | (1,923.7 | ) | (135.0 | )% | |||||||||
Retail gross margin | 95.0 | 566.4 | (471.4 | ) | (83.2 | )% | ||||||||||
Total Adjusted Gross Margin | $ | (403.5 | ) | $ | 1,991.6 | $ | (2,395.1 | ) | (120.3 | )% | ||||||
Factory adjusted gross margin | -23.4 | % | 25.4 | % | (48.8 | )% | (192.1 | )% | ||||||||
Retail gross margin | 50.6 | % | 66.3 | % | (15.7 | )% | (23.7 | )% | ||||||||
Total Adjusted Gross Margin | -17.4 | % | 30.8 | % | (48.2 | )% | (156.5 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 190 basis points in the three months ended August 31, 2019 compared to the three months ended August 31, 2018 because of a charge associated with costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production for the three months ended August 31, 2019 compared to the three months ended August 31, 2018. The decrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 2019 compared to the prior year.
Franchise Costs
The decrease in franchise costs in the three months ended August 31, 2019 versus the three months ended August 31, 2018 is due primarily to a decrease in legal and professional expense in the three months ended August 31, 2019 compared to the three months ended August 31, 2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to planned cost reductions as a result of fewer domestic franchise units in operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The increase in general and administrative costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses increased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 52.3% in the three months ended August 31, 2018 to 52.0% in the three months ended August 31, 2019. This decrease is primarily the result of the change in units in operation from the prior year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation. See Note 8 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7% from $138,000 in the three months ended August 31, 2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Costs Associated with Company-Owned Store Closures
There was $119,000 in costs associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no costs associated with company-owned store closures incurred during the three months ended August 31, 2019. The costs incurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest income was $3,000 in the three months ended August 31, 2019 compared to net interest expense of $15,000 incurred in the three months ended August 31, 2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 2019 was 26.4%, compared to 26.8% for the three months ended August 31, 2018.
Six Months Ended August 31, 2019 Compared to the Six Months Ended August 31, 2018
Results Summary
Basic earnings per share increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018. Revenues decreased (2.2)% to $15.8 million for the six months ended August 31, 2019 compared to $16.2 million in the six months ended August 31, 2018. Operating income increased 20.2% from $1.8 million in the six months ended August 31, 2018 to $2.2 million in the six months ended August 31, 2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018 to $1.6 million in the six months ended August 31, 2019. The increase in operating income and net income was due primarily to lower operating expenses in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 2019 versus the six months ended August 31, 2018 was primarily due to a 10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. The decrease in shipments of product to customers outside our network of franchise and licensed retail stores was primarily the result of product rationalization and a decline in revenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, FTD, were approximately $1.5 million, or 9.3%, of the Company’s revenues during the six months ended August 31, 2019, compared to $1.4 million, or 8.8% of the Company’s revenues during the six months ended August 31, 2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company will realize any revenue from FTD in the future, and if so, whether such revenues will return to historic levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 5.3% in the six months ended August 31, 2019, compared with the six months ended August 31, 2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to fewer Company-owned units in operation because of the closure of certain underperforming Company-owned locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés increased 0.2% in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Royalties, Marketing Fees and Franchise Fees
The increase in royalties and marketing fees from the six months ended August 31, 2018 to the six months ended August 31, 2019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 6.5% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 293 in the six months ended August 31, 2018 to 274 during the six months ended August 31, 2019. This decrease is the result of domestic store closures exceeding domestic store openings. Same store sales at total franchise stores and cafés in operation increased 0.5% during the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was the result of a decrease in revenue resulting from fewer franchise stores in operation and the associated recognition of revenue over the term of the franchise agreement.
Costs and Expenses
Cost of Sales
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider itthem in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Salesand Gross Margin
Factory gross margins decreased 110 basis pointsto negative gross margin of (23.4)% in the sixthree months ended AugustMay 31, 2020 compared to positive gross margin of 25.4% during the three months ended May 31, 2019, due primarily to lower production volume in the three months ended May 31, 2020 compared to the sixthree months ended AugustMay 31, 2018 because2019. During the three monthd ended May 31, 2020, production volume decreased 56.7% in response to a 61.9% decrease in factory sales, primarily due to the impacts of the COVID-19 pandemic. As a charge associated with costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6%the decrease in production forvolume, factory fixed costs, including idle labor, exceeded revenue during the sixthree months ended AugustMay 31, 2020. During the three months ended May 31, 2020 the Company incurred approximately $280,000 of production labor costs associated with paying employees who abided by local stay at home orders related to COVID-19 public health measures. This excess capacity cost, in the form of idle labor, was included in cost of sales.
Retail gross margins decreased from 66.3% during the three months ended May 31, 2019 compared to 50.6% during the sixthree months ended AugustMay 31, 2018.2020. The increasedecrease in retail gross margins was primarily the result of the temporary closure of underperformingall of our Company-owned locations duringstores for much of the prior fiscal year.three months ended May 31, 2020 due to the COVID-19 pandemic, and the associated impact on perishable inventory.
Franchise Costs
The decrease in franchise costs in the sixthree months ended AugustMay 31, 2020 compared to the three months ended May 31, 2019 versus the six months ended August 31, 2018 iswas due primarily to a decrease in legal and professional expenses.lower travel costs, the result of COVID-19 related travel restrictions. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreasedincreased to 23.3%90.3% in the sixthree months ended AugustMay 31, 20192020 from 28.0%24.6% in the sixthree months ended AugustMay 31, 2018.2019. This decreaseincrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise costs.royalty revenues.
Sales and Marketing
The decrease in sales and marketing costs for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 2018 is2019 was primarily due to planned cost reductions as a result of fewer domestic franchise unitslower advertising and promotion costs, partially offset by an increase in operation.online advertising cost.
General and Administrative
The increase in general and administrative costs for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 2018 is2019 was due primarily due to an increase in bad debt expense, the impairment of certain intangible assets and higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the six months ended August 31, 2018.fees. As a percentage of total revenues, general and administrative expenses increased to 12.5%117.7% in the sixthree months ended AugustMay 31, 20192020 compared to 10.7%13.6% in the sixthree months ended AugustMay 31, 2018.2019. Bad debt expense was primarily the result of management’s assessment of the likelihood of collecting accounts and notes receivable as of May 31, 2020. As a result of this assessment total allowances for potentially uncollectable accounts and notes receivable increased to $2,108,912 at May 31, 2020, compared to $557,916 at February 29, 2020. This cost was a direct result of public health measures in place due to responses to COVID-19 and the financial burden experienced by the majority of our network of franchised and licensed locations. See Note 8 to the financial statements for a summary of costs associated with the impairment of certain intangible assets.
Retail Operating Expenses
The decrease in retail operating expenses for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 20182019 was due primarily to changes in units in operation, as a resultthe temporary closure of all of our Company-owned stores for much of the three months ended May 31, 2020. The closure of certain underperformingour Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 53.7% in the six months ended August 31, 2018 to 52.3% in the six months ended August 31, 2019. This decrease is primarilystores was the result of COVID-19 and the changeassociated public health measures in units in operation fromplace during the prior year.three months ended May 31, 2020.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $457,000$186,000 in the sixthree months ended AugustMay 31, 2019,2020, a decrease of 23.5%20.0% from $598,000$232,000 incurred in the sixthree months ended AugustMay 31, 2018.2019. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation.operation and lower amortization of the associated franchise rights. See Note 87 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7%8.1% from $275,000$145,700 in the sixthree months ended AugustMay 31, 20182019 to $293,000$157,500 in the sixthree months ended AugustMay 31, 2019.2020. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.service.
Costs Associated with Company-Owned Store Closures
There was $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2019. The costs incurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Interest income was approximately equal toNet interest expense was $17,800 in the sixthree months ended AugustMay 31, 2019,2020 compared to net interest expense of $33,000 in$2,200 during the sixthree months ended AugustMay 31, 2018.2019. This decrease in interest expense is due to lower average outstanding promissory note balances forchange was primarily the sixresult of the Company’s increased debt as a result of measures taken during the three months ended AugustMay 31, 2019.2020 to ensure adequate liquidity during the COVID-19 pandemic. During the three months ended May 31, 2020, the Company borrowed $3.4 million from its line of credit and borrowed $1.5 million of loans under the Paychecks Protection Program.
Income Tax Expense
Our effective income tax rate was 24.3% for the sixthree months ended AugustMay 31, 20192020 and was 25.6%, compared to 25.9%24.6% for the sixthree months ended AugustMay 31, 2018. 2019.
Liquidity and Capital Resources
As discussed below, we have taken several defensive measures to maximize liquidity in response to the COVID-19 pandemic, including the suspension of Augustour cash dividend, reducing expenses, extending payment terms with vendors, reducing production volume and deferring discretionary capital expenditures. Based on these actions, we believe that cash flows from operations and our cash and cash equivalents on hand, will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additional future financing may be necessary to fund our operations, and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all, especially in light of the market volatility and uncertainty as a result of the COVID-19 pandemic. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, in each case, in light of the market volatility and uncertainty as a result of the COVID-19 pandemic, among other factors, could impact our business and liquidity.
As of May 31, 2019 and February 28, 2019,2020, working capital was $9.5$5.1 million, compared to $8.0 million as of February 29, 2020, a decrease of $2.9 million. The decrease in working capital was primarily due to an increase in current liabilities, the result of the Company’s response to COVID-19 and measures taken to ensure sufficient short-term liquidity.
Cash and cash equivalent balances increased approximately $400,000 to $5.8$2.6 million as of August 31, 2019 compared to $5.4from $4.8 million as of February 28, 2019,29, 2020 to $7.4 million as of May 31, 2020, primarily as a result of cash flow generated by operating activities exceeding cash flow used by financing activities, including repaymentthe use of debtthe line of credit and paymentreceipt of dividends.loans under the Paycheck Protection Program, as described below. Our current ratio was 2.91.5 to 1 at AugustMay 31, 20192020 compared to 3.02.4 to 1 at February 28, 2019.29, 2020. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the sixthree months ended AugustMay 31, 2019, we had net income of $1,629,697. Operating2020, operating activities providedused cash of $2,902,679, with$1,598,042, primarily the principal adjustment to reconcileresult of operating results, the net income to net cash provided by operating activities beingprovision for loss on accounts and notes receivable of $1,468,815, asset impairment and store closure losses of $544,060, depreciation and amortization of $750,486$343,115, an increase in accounts payble of $680,748 and the expense recorded for stockrelated to stock-based compensation of $386,670.$143,718. During the comparable 2018 period, we had net income of $1,327,759, andthree months ended May 31, 2019, operating activities provided cash of $1,388,429. The principal adjustment to reconcile$1,828,109, primarily the net income to net cash provided byresult of operating activities wasresults, depreciation and amortization of $872,454$377,654, a decrease in inventories of $344,058 and the increase in inventoryexpense related to stock-based compensation of $1,579,686. $231,254.
DuringFor the sixthree months ended AugustMay 31, 2019,2020, investing activities used cash of $406,376,$46,127, primarily due to the purchases of property and equipment and intangible assets of $480,984.$63,952. In comparison, investing activities used cash of $200,537$254,836 during the sixthree months ended AugustMay 31, 20182019, primarily due to the purchase of property and equipment of $242,432.$283,548.
Financing activities provided cash of $4,236,021 for the three months ended May 31, 2020, primarily as a as a result of the use of the line of credit and receipt of loans under the Paycheck Protection Program, as described below. In comparison, financing activitied used cash of $2,127,121 for$1,061,726 during the sixthree months ended AugustMay 31, 2019, primarily due to dividend payments and used cash of $2,087,641payments on debt during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.three months ended May 31, 2019.
We haveRevolving Credit Line
The Company has a $5.0 million ($5.0 million available as of August 31, 2019)credit line for general corporate and working capital purposes. On March 16, 2020, as a precautionary measure in light of the COVID-19 pandemic and the related economic impacts, the Company drew the maximum amount available on the credit line in an amount equal to $3.4 million (the full amount of $5.0 million under the credit collateralizedline, subject to the borrowing base of 50% of eligible accounts receivable plus 50% of eligible inventories). The credit line is secured by substantially all of ourthe Company’s assets, with the exception of ourexcept retail store assets. Interest on borrowings is at LIBOR plus 2.25% (2.4% at May 31, 2020). Additionally, the line of credit is subject to various financial ratio and leverage covenants. AsAt May 31, 2020, the Company was not compliant with a covenant of August 31, 2019, we were in compliance with all such covenants. Thethe line of credit was renewed in September 2019that requires the Company to have $1.5 million of adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the trailing twelve months ended May 31, 2020. As a result of COVID-19, the Company failed to meet the amount of EBITDA required by this covenant. On June 26, 2020 Wells Fargo Bank, NA (“Wells Fargo”) delivered to the Company a Reservation of Rights Letter (“Bank Letter”). The Bank Letter reserved all rights available to Wells Fargo under the Credit Agreement dated October 30, 2015 including, but not limited to, the right of Wells Fargo to demand immediate payment of all amounts outstanding under the Credit Agreement. The letter also placed restrictions on the Company’s ability to draw any further funds on the Line of Credit. The Company intends to work with Wells Fargo to amend the associated covenants as the trends related to COVID-19 begin become clear. There is no assurance that Wells Fargo will agree to any proposed amendment. The credit line is subject to renewal again in September 2021. As2021 and the Company believes it is likely to be renewed on terms similar to the current terms, subject to the Company’s recovery from the impacts of August 31, 2019, no amount was outstanding under this line of credit.COVID-19.
Our outstanding long-term debt is comprised of a promissory note used to finance business acquisitions of SWRL (unpaid balance as of August 31, 2019 of $480,000). The promissory note allowed us to borrow up to a maximum of $7.0 million to finance business acquisitions and bears interest at a fixed annual rate of 3.75%. The promissory note matures on January 15, 2020. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of August 31, 2019, we were in compliance with all such covenants.PPP Loan
On July 15, 2014, we publicly announcedApril 13, 2020 and April 20, 2020, the Company entered into a planLoan Agreements and Promissory Notes (collectively, the “SBA Loans”) with 1st SOURCE BANK pursuant to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stockPaycheck Protection Program (the “PPP”) under the repurchase plan,recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the U.S. Small Business Administration. The Company received total proceeds of $1.5 million from the SBA Loans. The SBA Loans are scheduled to mature on May 21, 2015, we announcedApril 14 and April 20, 2022 and have a further increase1.00% interest rate and are subject to the repurchase planterms and conditions applicable to loans administered by authorizing the purchase of up to an additional $2,090,000 of our common stockU.S. Small Business Administration under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2019. As of August 31, 2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generatedCARES Act. The SBA Loan may be prepaid by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of creditat any time prior to help meet these requirements.maturity with no prepayment penalties.
The SBA Loans contains customary events of default relating to, among other things, payment defaults and breaches of representations and warranties. Subject to certain conditions, the SBA Loans may be forgiven in whole or in part by applying for forgiveness pursuant to the CARES Act and the PPP. The amount of loan proceeds eligible for forgiveness is based on a formula based on a number of factors, including the amount of loan proceeds used by the Company during the eight-week period after the loan origination for certain purposes, including payroll costs, interest on certain mortgage obligations, rent payments on certain leases, and certain qualified utility payments, provided that, among other things, at least 75% of the loan amount is used for eligible payroll costs, the employer maintaining or rehiring employees and maintaining salaries at certain level. In accordance with the requirements of the CARES Act and the PPP, the Company intends to use the proceeds from the SBA Loans primarily for payroll costs. No assurance can be given that the Company will be granted forgiveness of the SBA Loans in whole or in part.
Off-Balance Sheet Arrangements
As of August 31, 2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of AugustMay 31, 2019,2020, we had purchase obligations of approximately $714,000.$227,000. These purchase obligations primarily consist of contractual obligations for future purchases of commodities for use in our manufacturing.
Impact of Inflation
Inflationary factors such as increases in the costs of ingredients and labor directly affect our operations. Most of our leases provide for cost-of-living adjustments and require us to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, our future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on increased costs to our customers.
Depreciation expense is based on the historical cost to us of our fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years will ultimately have to be replaced at higher prices, it is expected that replacement will be a gradual process over many years.
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and the summer vacation season. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of our business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year.
Quantitative and Qualitative Disclosures |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However,As a smaller reporting company, we are exposednot required to some commodity price and interest rate risks.provide the information required by this Item.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of AugustMay 31, 2019.2020.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended AugustMay 31, 20192020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2019.29, 2020. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2019.29, 2020.
Unregistered Sales of Equity Securities and Use of Proceeds |
Issuer Purchases of Equity Securities
None.None
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.applicable.
Other Information |
None.
Exhibits |
3.1 |
|
3.2 |
| |
10.2 |
32.1** | Certification Furnished Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002. |
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Executive Officer, | ||
Chief Financial Officer, Treasurer and |
2019
2018
Change
Change
2020
2019
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Three Months Ended | ||||||||||||||||
May 31, | % | % | ||||||||||||||
2020 | 2019 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | -30.7 | % | 22.8 | % | (53.5 | )% | (234.6 | )% | ||||||||
Retail gross margin | 50.6 | % | 66.3 | % | (15.7 | )% | (23.7 | )% | ||||||||
Total | -24.2 | % | 28.6 | % | (52.8 | )% | (184.6 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Three Months Ended | ||||||||||||||||
May 31, | $ | % | ||||||||||||||
($'s in thousands) | 2020 | 2019 | Change | Change | ||||||||||||
Factory gross margin | $ | (656.0 | ) | $ | 1,279.5 | $ | (1,935.5 | ) | (151.3 | )% | ||||||
Plus: depreciation and amortization | 157.5 | 145.7 | 11.8 | 8.1 | % | |||||||||||
Factory adjusted gross margin | (498.5 | ) | 1,425.2 | (1,923.7 | ) | (135.0 | )% | |||||||||
Retail gross margin | 95.0 | 566.4 | (471.4 | ) | (83.2 | )% | ||||||||||
Total Adjusted Gross Margin | $ | (403.5 | ) | $ | 1,991.6 | $ | (2,395.1 | ) | (120.3 | )% | ||||||
Factory adjusted gross margin | -23.4 | % | 25.4 | % | (48.8 | )% | (192.1 | )% | ||||||||
Retail gross margin | 50.6 | % | 66.3 | % | (15.7 | )% | (23.7 | )% | ||||||||
Total Adjusted Gross Margin | -17.4 | % | 30.8 | % | (48.2 | )% | (156.5 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 190 basis points in the three months ended August 31, 2019 compared to the three months ended August 31, 2018 because of a charge associated with costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production for the three months ended August 31, 2019 compared to the three months ended August 31, 2018. The decrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 2019 compared to the prior year.
Franchise Costs
The decrease in franchise costs in the three months ended August 31, 2019 versus the three months ended August 31, 2018 is due primarily to a decrease in legal and professional expense in the three months ended August 31, 2019 compared to the three months ended August 31, 2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to planned cost reductions as a result of fewer domestic franchise units in operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The increase in general and administrative costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses increased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 52.3% in the three months ended August 31, 2018 to 52.0% in the three months ended August 31, 2019. This decrease is primarily the result of the change in units in operation from the prior year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation. See Note 8 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7% from $138,000 in the three months ended August 31, 2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Costs Associated with Company-Owned Store Closures
There was $119,000 in costs associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no costs associated with company-owned store closures incurred during the three months ended August 31, 2019. The costs incurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest income was $3,000 in the three months ended August 31, 2019 compared to net interest expense of $15,000 incurred in the three months ended August 31, 2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 2019 was 26.4%, compared to 26.8% for the three months ended August 31, 2018.
Six Months Ended August 31, 2019 Compared to the Six Months Ended August 31, 2018
Results Summary
Basic earnings per share increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018. Revenues decreased (2.2)% to $15.8 million for the six months ended August 31, 2019 compared to $16.2 million in the six months ended August 31, 2018. Operating income increased 20.2% from $1.8 million in the six months ended August 31, 2018 to $2.2 million in the six months ended August 31, 2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018 to $1.6 million in the six months ended August 31, 2019. The increase in operating income and net income was due primarily to lower operating expenses in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 2019 versus the six months ended August 31, 2018 was primarily due to a 10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. The decrease in shipments of product to customers outside our network of franchise and licensed retail stores was primarily the result of product rationalization and a decline in revenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, FTD, were approximately $1.5 million, or 9.3%, of the Company’s revenues during the six months ended August 31, 2019, compared to $1.4 million, or 8.8% of the Company’s revenues during the six months ended August 31, 2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company will realize any revenue from FTD in the future, and if so, whether such revenues will return to historic levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 5.3% in the six months ended August 31, 2019, compared with the six months ended August 31, 2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to fewer Company-owned units in operation because of the closure of certain underperforming Company-owned locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés increased 0.2% in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Royalties, Marketing Fees and Franchise Fees
The increase in royalties and marketing fees from the six months ended August 31, 2018 to the six months ended August 31, 2019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 6.5% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 293 in the six months ended August 31, 2018 to 274 during the six months ended August 31, 2019. This decrease is the result of domestic store closures exceeding domestic store openings. Same store sales at total franchise stores and cafés in operation increased 0.5% during the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was the result of a decrease in revenue resulting from fewer franchise stores in operation and the associated recognition of revenue over the term of the franchise agreement.
Costs and Expenses
Cost of Sales
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider itthem in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Salesand Gross Margin
Factory gross margins decreased 110 basis pointsto negative gross margin of (23.4)% in the sixthree months ended AugustMay 31, 2020 compared to positive gross margin of 25.4% during the three months ended May 31, 2019, due primarily to lower production volume in the three months ended May 31, 2020 compared to the sixthree months ended AugustMay 31, 2018 because2019. During the three monthd ended May 31, 2020, production volume decreased 56.7% in response to a 61.9% decrease in factory sales, primarily due to the impacts of the COVID-19 pandemic. As a charge associated with costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6%the decrease in production forvolume, factory fixed costs, including idle labor, exceeded revenue during the sixthree months ended AugustMay 31, 2020. During the three months ended May 31, 2020 the Company incurred approximately $280,000 of production labor costs associated with paying employees who abided by local stay at home orders related to COVID-19 public health measures. This excess capacity cost, in the form of idle labor, was included in cost of sales.
Retail gross margins decreased from 66.3% during the three months ended May 31, 2019 compared to 50.6% during the sixthree months ended AugustMay 31, 2018.2020. The increasedecrease in retail gross margins was primarily the result of the temporary closure of underperformingall of our Company-owned locations duringstores for much of the prior fiscal year.three months ended May 31, 2020 due to the COVID-19 pandemic, and the associated impact on perishable inventory.
Franchise Costs
The decrease in franchise costs in the sixthree months ended AugustMay 31, 2020 compared to the three months ended May 31, 2019 versus the six months ended August 31, 2018 iswas due primarily to a decrease in legal and professional expenses.lower travel costs, the result of COVID-19 related travel restrictions. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreasedincreased to 23.3%90.3% in the sixthree months ended AugustMay 31, 20192020 from 28.0%24.6% in the sixthree months ended AugustMay 31, 2018.2019. This decreaseincrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise costs.royalty revenues.
Sales and Marketing
The decrease in sales and marketing costs for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 2018 is2019 was primarily due to planned cost reductions as a result of fewer domestic franchise unitslower advertising and promotion costs, partially offset by an increase in operation.online advertising cost.
General and Administrative
The increase in general and administrative costs for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 2018 is2019 was due primarily due to an increase in bad debt expense, the impairment of certain intangible assets and higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the six months ended August 31, 2018.fees. As a percentage of total revenues, general and administrative expenses increased to 12.5%117.7% in the sixthree months ended AugustMay 31, 20192020 compared to 10.7%13.6% in the sixthree months ended AugustMay 31, 2018.2019. Bad debt expense was primarily the result of management’s assessment of the likelihood of collecting accounts and notes receivable as of May 31, 2020. As a result of this assessment total allowances for potentially uncollectable accounts and notes receivable increased to $2,108,912 at May 31, 2020, compared to $557,916 at February 29, 2020. This cost was a direct result of public health measures in place due to responses to COVID-19 and the financial burden experienced by the majority of our network of franchised and licensed locations. See Note 8 to the financial statements for a summary of costs associated with the impairment of certain intangible assets.
Retail Operating Expenses
The decrease in retail operating expenses for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 20182019 was due primarily to changes in units in operation, as a resultthe temporary closure of all of our Company-owned stores for much of the three months ended May 31, 2020. The closure of certain underperformingour Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 53.7% in the six months ended August 31, 2018 to 52.3% in the six months ended August 31, 2019. This decrease is primarilystores was the result of COVID-19 and the changeassociated public health measures in units in operation fromplace during the prior year.three months ended May 31, 2020.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $457,000$186,000 in the sixthree months ended AugustMay 31, 2019,2020, a decrease of 23.5%20.0% from $598,000$232,000 incurred in the sixthree months ended AugustMay 31, 2018.2019. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation.operation and lower amortization of the associated franchise rights. See Note 87 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7%8.1% from $275,000$145,700 in the sixthree months ended AugustMay 31, 20182019 to $293,000$157,500 in the sixthree months ended AugustMay 31, 2019.2020. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.service.
Costs Associated with Company-Owned Store Closures
There was $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2019. The costs incurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Interest income was approximately equal toNet interest expense was $17,800 in the sixthree months ended AugustMay 31, 2019,2020 compared to net interest expense of $33,000 in$2,200 during the sixthree months ended AugustMay 31, 2018.2019. This decrease in interest expense is due to lower average outstanding promissory note balances forchange was primarily the sixresult of the Company’s increased debt as a result of measures taken during the three months ended AugustMay 31, 2019.2020 to ensure adequate liquidity during the COVID-19 pandemic. During the three months ended May 31, 2020, the Company borrowed $3.4 million from its line of credit and borrowed $1.5 million of loans under the Paychecks Protection Program.
Income Tax Expense
Our effective income tax rate was 24.3% for the sixthree months ended AugustMay 31, 20192020 and was 25.6%, compared to 25.9%24.6% for the sixthree months ended AugustMay 31, 2018. 2019.
Liquidity and Capital Resources
As discussed below, we have taken several defensive measures to maximize liquidity in response to the COVID-19 pandemic, including the suspension of Augustour cash dividend, reducing expenses, extending payment terms with vendors, reducing production volume and deferring discretionary capital expenditures. Based on these actions, we believe that cash flows from operations and our cash and cash equivalents on hand, will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additional future financing may be necessary to fund our operations, and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all, especially in light of the market volatility and uncertainty as a result of the COVID-19 pandemic. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, in each case, in light of the market volatility and uncertainty as a result of the COVID-19 pandemic, among other factors, could impact our business and liquidity.
As of May 31, 2019 and February 28, 2019,2020, working capital was $9.5$5.1 million, compared to $8.0 million as of February 29, 2020, a decrease of $2.9 million. The decrease in working capital was primarily due to an increase in current liabilities, the result of the Company’s response to COVID-19 and measures taken to ensure sufficient short-term liquidity.
Cash and cash equivalent balances increased approximately $400,000 to $5.8$2.6 million as of August 31, 2019 compared to $5.4from $4.8 million as of February 28, 2019,29, 2020 to $7.4 million as of May 31, 2020, primarily as a result of cash flow generated by operating activities exceeding cash flow used by financing activities, including repaymentthe use of debtthe line of credit and paymentreceipt of dividends.loans under the Paycheck Protection Program, as described below. Our current ratio was 2.91.5 to 1 at AugustMay 31, 20192020 compared to 3.02.4 to 1 at February 28, 2019.29, 2020. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the sixthree months ended AugustMay 31, 2019, we had net income of $1,629,697. Operating2020, operating activities providedused cash of $2,902,679, with$1,598,042, primarily the principal adjustment to reconcileresult of operating results, the net income to net cash provided by operating activities beingprovision for loss on accounts and notes receivable of $1,468,815, asset impairment and store closure losses of $544,060, depreciation and amortization of $750,486$343,115, an increase in accounts payble of $680,748 and the expense recorded for stockrelated to stock-based compensation of $386,670.$143,718. During the comparable 2018 period, we had net income of $1,327,759, andthree months ended May 31, 2019, operating activities provided cash of $1,388,429. The principal adjustment to reconcile$1,828,109, primarily the net income to net cash provided byresult of operating activities wasresults, depreciation and amortization of $872,454$377,654, a decrease in inventories of $344,058 and the increase in inventoryexpense related to stock-based compensation of $1,579,686. $231,254.
DuringFor the sixthree months ended AugustMay 31, 2019,2020, investing activities used cash of $406,376,$46,127, primarily due to the purchases of property and equipment and intangible assets of $480,984.$63,952. In comparison, investing activities used cash of $200,537$254,836 during the sixthree months ended AugustMay 31, 20182019, primarily due to the purchase of property and equipment of $242,432.$283,548.
Financing activities provided cash of $4,236,021 for the three months ended May 31, 2020, primarily as a as a result of the use of the line of credit and receipt of loans under the Paycheck Protection Program, as described below. In comparison, financing activitied used cash of $2,127,121 for$1,061,726 during the sixthree months ended AugustMay 31, 2019, primarily due to dividend payments and used cash of $2,087,641payments on debt during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.three months ended May 31, 2019.
We haveRevolving Credit Line
The Company has a $5.0 million ($5.0 million available as of August 31, 2019)credit line for general corporate and working capital purposes. On March 16, 2020, as a precautionary measure in light of the COVID-19 pandemic and the related economic impacts, the Company drew the maximum amount available on the credit line in an amount equal to $3.4 million (the full amount of $5.0 million under the credit collateralizedline, subject to the borrowing base of 50% of eligible accounts receivable plus 50% of eligible inventories). The credit line is secured by substantially all of ourthe Company’s assets, with the exception of ourexcept retail store assets. Interest on borrowings is at LIBOR plus 2.25% (2.4% at May 31, 2020). Additionally, the line of credit is subject to various financial ratio and leverage covenants. AsAt May 31, 2020, the Company was not compliant with a covenant of August 31, 2019, we were in compliance with all such covenants. Thethe line of credit was renewed in September 2019that requires the Company to have $1.5 million of adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the trailing twelve months ended May 31, 2020. As a result of COVID-19, the Company failed to meet the amount of EBITDA required by this covenant. On June 26, 2020 Wells Fargo Bank, NA (“Wells Fargo”) delivered to the Company a Reservation of Rights Letter (“Bank Letter”). The Bank Letter reserved all rights available to Wells Fargo under the Credit Agreement dated October 30, 2015 including, but not limited to, the right of Wells Fargo to demand immediate payment of all amounts outstanding under the Credit Agreement. The letter also placed restrictions on the Company’s ability to draw any further funds on the Line of Credit. The Company intends to work with Wells Fargo to amend the associated covenants as the trends related to COVID-19 begin become clear. There is no assurance that Wells Fargo will agree to any proposed amendment. The credit line is subject to renewal again in September 2021. As2021 and the Company believes it is likely to be renewed on terms similar to the current terms, subject to the Company’s recovery from the impacts of August 31, 2019, no amount was outstanding under this line of credit.COVID-19.
Our outstanding long-term debt is comprised of a promissory note used to finance business acquisitions of SWRL (unpaid balance as of August 31, 2019 of $480,000). The promissory note allowed us to borrow up to a maximum of $7.0 million to finance business acquisitions and bears interest at a fixed annual rate of 3.75%. The promissory note matures on January 15, 2020. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of August 31, 2019, we were in compliance with all such covenants.PPP Loan
On July 15, 2014, we publicly announcedApril 13, 2020 and April 20, 2020, the Company entered into a planLoan Agreements and Promissory Notes (collectively, the “SBA Loans”) with 1st SOURCE BANK pursuant to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stockPaycheck Protection Program (the “PPP”) under the repurchase plan,recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the U.S. Small Business Administration. The Company received total proceeds of $1.5 million from the SBA Loans. The SBA Loans are scheduled to mature on May 21, 2015, we announcedApril 14 and April 20, 2022 and have a further increase1.00% interest rate and are subject to the repurchase planterms and conditions applicable to loans administered by authorizing the purchase of up to an additional $2,090,000 of our common stockU.S. Small Business Administration under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2019. As of August 31, 2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generatedCARES Act. The SBA Loan may be prepaid by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of creditat any time prior to help meet these requirements.maturity with no prepayment penalties.
The SBA Loans contains customary events of default relating to, among other things, payment defaults and breaches of representations and warranties. Subject to certain conditions, the SBA Loans may be forgiven in whole or in part by applying for forgiveness pursuant to the CARES Act and the PPP. The amount of loan proceeds eligible for forgiveness is based on a formula based on a number of factors, including the amount of loan proceeds used by the Company during the eight-week period after the loan origination for certain purposes, including payroll costs, interest on certain mortgage obligations, rent payments on certain leases, and certain qualified utility payments, provided that, among other things, at least 75% of the loan amount is used for eligible payroll costs, the employer maintaining or rehiring employees and maintaining salaries at certain level. In accordance with the requirements of the CARES Act and the PPP, the Company intends to use the proceeds from the SBA Loans primarily for payroll costs. No assurance can be given that the Company will be granted forgiveness of the SBA Loans in whole or in part.
Off-Balance Sheet Arrangements
As of August 31, 2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of AugustMay 31, 2019,2020, we had purchase obligations of approximately $714,000.$227,000. These purchase obligations primarily consist of contractual obligations for future purchases of commodities for use in our manufacturing.
Impact of Inflation
Inflationary factors such as increases in the costs of ingredients and labor directly affect our operations. Most of our leases provide for cost-of-living adjustments and require us to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, our future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on increased costs to our customers.
Depreciation expense is based on the historical cost to us of our fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years will ultimately have to be replaced at higher prices, it is expected that replacement will be a gradual process over many years.
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and the summer vacation season. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of our business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year.
Quantitative and Qualitative Disclosures |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However,As a smaller reporting company, we are exposednot required to some commodity price and interest rate risks.provide the information required by this Item.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of AugustMay 31, 2019.2020.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended AugustMay 31, 20192020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2019.29, 2020. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2019.29, 2020.
Unregistered Sales of Equity Securities and Use of Proceeds |
Issuer Purchases of Equity Securities
None.None
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.applicable.
Other Information |
None.
Exhibits |
3.1 |
|
3.2 |
| |
10.2 |
32.1** | Certification Furnished Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002. |
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Executive Officer, | ||
Chief Financial Officer, Treasurer and |
2019
2018
Change
Change
2020
2019
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
May 31, | $ | % | ||||||||||||||
($'s in thousands) | 2020 | 2019 | Change | Change | ||||||||||||
Factory gross margin | $ | (656.0 | ) | $ | 1,279.5 | $ | (1,935.5 | ) | (151.3 | )% | ||||||
Retail gross margin | 95.0 | 566.4 | (471.4 | ) | (83.2 | )% | ||||||||||
Total | $ | (561.0 | ) | $ | 1,845.9 | $ | (2,406.9 | ) | (130.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Three Months Ended | ||||||||||||||||
May 31, | % | % | ||||||||||||||
2020 | 2019 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | -30.7 | % | 22.8 | % | (53.5 | )% | (234.6 | )% | ||||||||
Retail gross margin | 50.6 | % | 66.3 | % | (15.7 | )% | (23.7 | )% | ||||||||
Total | -24.2 | % | 28.6 | % | (52.8 | )% | (184.6 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Three Months Ended | ||||||||||||||||
May 31, | $ | % | ||||||||||||||
($'s in thousands) | 2020 | 2019 | Change | Change | ||||||||||||
Factory gross margin | $ | (656.0 | ) | $ | 1,279.5 | $ | (1,935.5 | ) | (151.3 | )% | ||||||
Plus: depreciation and amortization | 157.5 | 145.7 | 11.8 | 8.1 | % | |||||||||||
Factory adjusted gross margin | (498.5 | ) | 1,425.2 | (1,923.7 | ) | (135.0 | )% | |||||||||
Retail gross margin | 95.0 | 566.4 | (471.4 | ) | (83.2 | )% | ||||||||||
Total Adjusted Gross Margin | $ | (403.5 | ) | $ | 1,991.6 | $ | (2,395.1 | ) | (120.3 | )% | ||||||
Factory adjusted gross margin | -23.4 | % | 25.4 | % | (48.8 | )% | (192.1 | )% | ||||||||
Retail gross margin | 50.6 | % | 66.3 | % | (15.7 | )% | (23.7 | )% | ||||||||
Total Adjusted Gross Margin | -17.4 | % | 30.8 | % | (48.2 | )% | (156.5 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 190 basis points in the three months ended August 31, 2019 compared to the three months ended August 31, 2018 because of a charge associated with costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production for the three months ended August 31, 2019 compared to the three months ended August 31, 2018. The decrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 2019 compared to the prior year.
Franchise Costs
The decrease in franchise costs in the three months ended August 31, 2019 versus the three months ended August 31, 2018 is due primarily to a decrease in legal and professional expense in the three months ended August 31, 2019 compared to the three months ended August 31, 2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to planned cost reductions as a result of fewer domestic franchise units in operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The increase in general and administrative costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses increased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 52.3% in the three months ended August 31, 2018 to 52.0% in the three months ended August 31, 2019. This decrease is primarily the result of the change in units in operation from the prior year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation. See Note 8 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7% from $138,000 in the three months ended August 31, 2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Costs Associated with Company-Owned Store Closures
There was $119,000 in costs associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no costs associated with company-owned store closures incurred during the three months ended August 31, 2019. The costs incurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest income was $3,000 in the three months ended August 31, 2019 compared to net interest expense of $15,000 incurred in the three months ended August 31, 2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 2019 was 26.4%, compared to 26.8% for the three months ended August 31, 2018.
Six Months Ended August 31, 2019 Compared to the Six Months Ended August 31, 2018
Results Summary
Basic earnings per share increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018. Revenues decreased (2.2)% to $15.8 million for the six months ended August 31, 2019 compared to $16.2 million in the six months ended August 31, 2018. Operating income increased 20.2% from $1.8 million in the six months ended August 31, 2018 to $2.2 million in the six months ended August 31, 2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018 to $1.6 million in the six months ended August 31, 2019. The increase in operating income and net income was due primarily to lower operating expenses in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 2019 versus the six months ended August 31, 2018 was primarily due to a 10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. The decrease in shipments of product to customers outside our network of franchise and licensed retail stores was primarily the result of product rationalization and a decline in revenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, FTD, were approximately $1.5 million, or 9.3%, of the Company’s revenues during the six months ended August 31, 2019, compared to $1.4 million, or 8.8% of the Company’s revenues during the six months ended August 31, 2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company will realize any revenue from FTD in the future, and if so, whether such revenues will return to historic levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 5.3% in the six months ended August 31, 2019, compared with the six months ended August 31, 2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to fewer Company-owned units in operation because of the closure of certain underperforming Company-owned locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés increased 0.2% in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Royalties, Marketing Fees and Franchise Fees
The increase in royalties and marketing fees from the six months ended August 31, 2018 to the six months ended August 31, 2019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 6.5% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 293 in the six months ended August 31, 2018 to 274 during the six months ended August 31, 2019. This decrease is the result of domestic store closures exceeding domestic store openings. Same store sales at total franchise stores and cafés in operation increased 0.5% during the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was the result of a decrease in revenue resulting from fewer franchise stores in operation and the associated recognition of revenue over the term of the franchise agreement.
Costs and Expenses
Cost of Sales
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider itthem in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Salesand Gross Margin
Factory gross margins decreased 110 basis pointsto negative gross margin of (23.4)% in the sixthree months ended AugustMay 31, 2020 compared to positive gross margin of 25.4% during the three months ended May 31, 2019, due primarily to lower production volume in the three months ended May 31, 2020 compared to the sixthree months ended AugustMay 31, 2018 because2019. During the three monthd ended May 31, 2020, production volume decreased 56.7% in response to a 61.9% decrease in factory sales, primarily due to the impacts of the COVID-19 pandemic. As a charge associated with costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6%the decrease in production forvolume, factory fixed costs, including idle labor, exceeded revenue during the sixthree months ended AugustMay 31, 2020. During the three months ended May 31, 2020 the Company incurred approximately $280,000 of production labor costs associated with paying employees who abided by local stay at home orders related to COVID-19 public health measures. This excess capacity cost, in the form of idle labor, was included in cost of sales.
Retail gross margins decreased from 66.3% during the three months ended May 31, 2019 compared to 50.6% during the sixthree months ended AugustMay 31, 2018.2020. The increasedecrease in retail gross margins was primarily the result of the temporary closure of underperformingall of our Company-owned locations duringstores for much of the prior fiscal year.three months ended May 31, 2020 due to the COVID-19 pandemic, and the associated impact on perishable inventory.
Franchise Costs
The decrease in franchise costs in the sixthree months ended AugustMay 31, 2020 compared to the three months ended May 31, 2019 versus the six months ended August 31, 2018 iswas due primarily to a decrease in legal and professional expenses.lower travel costs, the result of COVID-19 related travel restrictions. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreasedincreased to 23.3%90.3% in the sixthree months ended AugustMay 31, 20192020 from 28.0%24.6% in the sixthree months ended AugustMay 31, 2018.2019. This decreaseincrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise costs.royalty revenues.
Sales and Marketing
The decrease in sales and marketing costs for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 2018 is2019 was primarily due to planned cost reductions as a result of fewer domestic franchise unitslower advertising and promotion costs, partially offset by an increase in operation.online advertising cost.
General and Administrative
The increase in general and administrative costs for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 2018 is2019 was due primarily due to an increase in bad debt expense, the impairment of certain intangible assets and higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the six months ended August 31, 2018.fees. As a percentage of total revenues, general and administrative expenses increased to 12.5%117.7% in the sixthree months ended AugustMay 31, 20192020 compared to 10.7%13.6% in the sixthree months ended AugustMay 31, 2018.2019. Bad debt expense was primarily the result of management’s assessment of the likelihood of collecting accounts and notes receivable as of May 31, 2020. As a result of this assessment total allowances for potentially uncollectable accounts and notes receivable increased to $2,108,912 at May 31, 2020, compared to $557,916 at February 29, 2020. This cost was a direct result of public health measures in place due to responses to COVID-19 and the financial burden experienced by the majority of our network of franchised and licensed locations. See Note 8 to the financial statements for a summary of costs associated with the impairment of certain intangible assets.
Retail Operating Expenses
The decrease in retail operating expenses for the sixthree months ended AugustMay 31, 20192020 compared to the sixthree months ended AugustMay 31, 20182019 was due primarily to changes in units in operation, as a resultthe temporary closure of all of our Company-owned stores for much of the three months ended May 31, 2020. The closure of certain underperformingour Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 53.7% in the six months ended August 31, 2018 to 52.3% in the six months ended August 31, 2019. This decrease is primarilystores was the result of COVID-19 and the changeassociated public health measures in units in operation fromplace during the prior year.three months ended May 31, 2020.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $457,000$186,000 in the sixthree months ended AugustMay 31, 2019,2020, a decrease of 23.5%20.0% from $598,000$232,000 incurred in the sixthree months ended AugustMay 31, 2018.2019. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation.operation and lower amortization of the associated franchise rights. See Note 87 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7%8.1% from $275,000$145,700 in the sixthree months ended AugustMay 31, 20182019 to $293,000$157,500 in the sixthree months ended AugustMay 31, 2019.2020. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.service.
Costs Associated with Company-Owned Store Closures
There was $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2019. The costs incurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Interest income was approximately equal toNet interest expense was $17,800 in the sixthree months ended AugustMay 31, 2019,2020 compared to net interest expense of $33,000 in$2,200 during the sixthree months ended AugustMay 31, 2018.2019. This decrease in interest expense is due to lower average outstanding promissory note balances forchange was primarily the sixresult of the Company’s increased debt as a result of measures taken during the three months ended AugustMay 31, 2019.2020 to ensure adequate liquidity during the COVID-19 pandemic. During the three months ended May 31, 2020, the Company borrowed $3.4 million from its line of credit and borrowed $1.5 million of loans under the Paychecks Protection Program.
Income Tax Expense
Our effective income tax rate was 24.3% for the sixthree months ended AugustMay 31, 20192020 and was 25.6%, compared to 25.9%24.6% for the sixthree months ended AugustMay 31, 2018. 2019.
Liquidity and Capital Resources
As discussed below, we have taken several defensive measures to maximize liquidity in response to the COVID-19 pandemic, including the suspension of Augustour cash dividend, reducing expenses, extending payment terms with vendors, reducing production volume and deferring discretionary capital expenditures. Based on these actions, we believe that cash flows from operations and our cash and cash equivalents on hand, will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additional future financing may be necessary to fund our operations, and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all, especially in light of the market volatility and uncertainty as a result of the COVID-19 pandemic. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, in each case, in light of the market volatility and uncertainty as a result of the COVID-19 pandemic, among other factors, could impact our business and liquidity.
As of May 31, 2019 and February 28, 2019,2020, working capital was $9.5$5.1 million, compared to $8.0 million as of February 29, 2020, a decrease of $2.9 million. The decrease in working capital was primarily due to an increase in current liabilities, the result of the Company’s response to COVID-19 and measures taken to ensure sufficient short-term liquidity.
Cash and cash equivalent balances increased approximately $400,000 to $5.8$2.6 million as of August 31, 2019 compared to $5.4from $4.8 million as of February 28, 2019,29, 2020 to $7.4 million as of May 31, 2020, primarily as a result of cash flow generated by operating activities exceeding cash flow used by financing activities, including repaymentthe use of debtthe line of credit and paymentreceipt of dividends.loans under the Paycheck Protection Program, as described below. Our current ratio was 2.91.5 to 1 at AugustMay 31, 20192020 compared to 3.02.4 to 1 at February 28, 2019.29, 2020. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the sixthree months ended AugustMay 31, 2019, we had net income of $1,629,697. Operating2020, operating activities providedused cash of $2,902,679, with$1,598,042, primarily the principal adjustment to reconcileresult of operating results, the net income to net cash provided by operating activities beingprovision for loss on accounts and notes receivable of $1,468,815, asset impairment and store closure losses of $544,060, depreciation and amortization of $750,486$343,115, an increase in accounts payble of $680,748 and the expense recorded for stockrelated to stock-based compensation of $386,670.$143,718. During the comparable 2018 period, we had net income of $1,327,759, andthree months ended May 31, 2019, operating activities provided cash of $1,388,429. The principal adjustment to reconcile$1,828,109, primarily the net income to net cash provided byresult of operating activities wasresults, depreciation and amortization of $872,454$377,654, a decrease in inventories of $344,058 and the increase in inventoryexpense related to stock-based compensation of $1,579,686. $231,254.
DuringFor the sixthree months ended AugustMay 31, 2019,2020, investing activities used cash of $406,376,$46,127, primarily due to the purchases of property and equipment and intangible assets of $480,984.$63,952. In comparison, investing activities used cash of $200,537$254,836 during the sixthree months ended AugustMay 31, 20182019, primarily due to the purchase of property and equipment of $242,432.$283,548.
Financing activities provided cash of $4,236,021 for the three months ended May 31, 2020, primarily as a as a result of the use of the line of credit and receipt of loans under the Paycheck Protection Program, as described below. In comparison, financing activitied used cash of $2,127,121 for$1,061,726 during the sixthree months ended AugustMay 31, 2019, primarily due to dividend payments and used cash of $2,087,641payments on debt during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.three months ended May 31, 2019.
We haveRevolving Credit Line
The Company has a $5.0 million ($5.0 million available as of August 31, 2019)credit line for general corporate and working capital purposes. On March 16, 2020, as a precautionary measure in light of the COVID-19 pandemic and the related economic impacts, the Company drew the maximum amount available on the credit line in an amount equal to $3.4 million (the full amount of $5.0 million under the credit collateralizedline, subject to the borrowing base of 50% of eligible accounts receivable plus 50% of eligible inventories). The credit line is secured by substantially all of ourthe Company’s assets, with the exception of ourexcept retail store assets. Interest on borrowings is at LIBOR plus 2.25% (2.4% at May 31, 2020). Additionally, the line of credit is subject to various financial ratio and leverage covenants. AsAt May 31, 2020, the Company was not compliant with a covenant of August 31, 2019, we were in compliance with all such covenants. Thethe line of credit was renewed in September 2019that requires the Company to have $1.5 million of adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the trailing twelve months ended May 31, 2020. As a result of COVID-19, the Company failed to meet the amount of EBITDA required by this covenant. On June 26, 2020 Wells Fargo Bank, NA (“Wells Fargo”) delivered to the Company a Reservation of Rights Letter (“Bank Letter”). The Bank Letter reserved all rights available to Wells Fargo under the Credit Agreement dated October 30, 2015 including, but not limited to, the right of Wells Fargo to demand immediate payment of all amounts outstanding under the Credit Agreement. The letter also placed restrictions on the Company’s ability to draw any further funds on the Line of Credit. The Company intends to work with Wells Fargo to amend the associated covenants as the trends related to COVID-19 begin become clear. There is no assurance that Wells Fargo will agree to any proposed amendment. The credit line is subject to renewal again in September 2021. As2021 and the Company believes it is likely to be renewed on terms similar to the current terms, subject to the Company’s recovery from the impacts of August 31, 2019, no amount was outstanding under this line of credit.COVID-19.
Our outstanding long-term debt is comprised of a promissory note used to finance business acquisitions of SWRL (unpaid balance as of August 31, 2019 of $480,000). The promissory note allowed us to borrow up to a maximum of $7.0 million to finance business acquisitions and bears interest at a fixed annual rate of 3.75%. The promissory note matures on January 15, 2020. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of August 31, 2019, we were in compliance with all such covenants.PPP Loan
On July 15, 2014, we publicly announcedApril 13, 2020 and April 20, 2020, the Company entered into a planLoan Agreements and Promissory Notes (collectively, the “SBA Loans”) with 1st SOURCE BANK pursuant to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stockPaycheck Protection Program (the “PPP”) under the repurchase plan,recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the U.S. Small Business Administration. The Company received total proceeds of $1.5 million from the SBA Loans. The SBA Loans are scheduled to mature on May 21, 2015, we announcedApril 14 and April 20, 2022 and have a further increase1.00% interest rate and are subject to the repurchase planterms and conditions applicable to loans administered by authorizing the purchase of up to an additional $2,090,000 of our common stockU.S. Small Business Administration under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2019. As of August 31, 2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generatedCARES Act. The SBA Loan may be prepaid by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of creditat any time prior to help meet these requirements.maturity with no prepayment penalties.
The SBA Loans contains customary events of default relating to, among other things, payment defaults and breaches of representations and warranties. Subject to certain conditions, the SBA Loans may be forgiven in whole or in part by applying for forgiveness pursuant to the CARES Act and the PPP. The amount of loan proceeds eligible for forgiveness is based on a formula based on a number of factors, including the amount of loan proceeds used by the Company during the eight-week period after the loan origination for certain purposes, including payroll costs, interest on certain mortgage obligations, rent payments on certain leases, and certain qualified utility payments, provided that, among other things, at least 75% of the loan amount is used for eligible payroll costs, the employer maintaining or rehiring employees and maintaining salaries at certain level. In accordance with the requirements of the CARES Act and the PPP, the Company intends to use the proceeds from the SBA Loans primarily for payroll costs. No assurance can be given that the Company will be granted forgiveness of the SBA Loans in whole or in part.
Off-Balance Sheet Arrangements
As of August 31, 2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of AugustMay 31, 2019,2020, we had purchase obligations of approximately $714,000.$227,000. These purchase obligations primarily consist of contractual obligations for future purchases of commodities for use in our manufacturing.
Impact of Inflation
Inflationary factors such as increases in the costs of ingredients and labor directly affect our operations. Most of our leases provide for cost-of-living adjustments and require us to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, our future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on increased costs to our customers.
Depreciation expense is based on the historical cost to us of our fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years will ultimately have to be replaced at higher prices, it is expected that replacement will be a gradual process over many years.
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and the summer vacation season. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of our business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year.
Quantitative and Qualitative Disclosures |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However,As a smaller reporting company, we are exposednot required to some commodity price and interest rate risks.provide the information required by this Item.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of AugustMay 31, 2019.2020.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended AugustMay 31, 20192020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2019.29, 2020. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2019.29, 2020.
Unregistered Sales of Equity Securities and Use of Proceeds |
Issuer Purchases of Equity Securities
None.None
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.applicable.
Other Information |
None.
Exhibits |
3.1 |
|
3.2 |
| |
10.2 |
32.1** | Certification Furnished Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002. |
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Executive Officer, | ||
Chief Financial Officer, Treasurer and |